Recessions Made Really Simple

One word with which we are all unfortunately familiar is "recession". In a free market economy, a recession is a significant decrease in business activity over a period of time. But stop and think for a minute, if the population and production capacity are continuously increasing, why should there ever be a recession unless there is some kind of natural disaster or other calamity? We should always be at maximum possible productivity so why do recessions seem to just come along periodically?

Today, I would like to introduce my economic theory to explain recession in a new way.

HOW MARKET FORCES BRING ABOUT RECESSIONS

As we know, a country prints money for the purpose of financial transactions because barter would be too cumbersome. The supply of money in a country is exactly equal in value to all of the goods and services produced by that country that can be exchanged for money. The money supply is thus a mirror image of the value of the production.

My economic theory revolves around the idea of the pathway along which the economy moves. On one side of the pathway is inflation and on the other side is recession. When we mint more money without a corresponding increase in the production of goods and services, it inevitably brings down the value of each unit of currency since the money supply must be a mirror image of the goods and services produced. The free market automatically corrects and the resulting decrease in value of the currency is known as inflation.

Inflation can be caused by natural factors such as drought or raw material shortages but I define inflation as a tax when it is caused by the overprinting of money because it gives the government more money to spend but the consumers pay for it not by direct payment of taxes but by higher prices for consumer goods caused by the overprinting.

Inflation is not good. It hinders lending and investment by eroding away the returns. If someone invests money at 6% interest but there is 4% inflation, their return is only 2%. Inflation causes consumers to focus on essentials so that companies making and marketing less-essential goods struggle or may go out of business. Inflation can lead to recession by hundering spending.

If the economy strays too far to the other side of the path, the result is recession not resulting from inflation. In my view, although recession is often portrayed as an unfortunate event that comes along once in a while, it is, in fact, a natural part of the way the economy is set up. We are familiar with the fundamental law of supply and demand that underlies a free market economy, prices increase when demand is high relative to supply and decrease when supply is high relative to demand. In my theory, we have the economy set up so that periodic rescessions come about by the same law of supply and demand.

In reality, a recession is an absurd situation in which workers produce goods and services but when they go to market, they cannot afford to buy the goods and services that they have produced. This means that production of those goods and services must be cut back since it makes no sense to produce goods and service that will not sell. That means that some of the workers must be laid off (made redundant) so that the workers as a whole have even less money to buy goods and services. That means that production must be curtailed further, and so on. This is a truly absurd and non-sensical situation yet it is what happens every few years.

A recession can be caused by any change in production, either an increase or decrease. If it is a decrease in production caused by drought or other calamity, we will call that a "real recession". But if it is actually an increase in production that leads to recession, it is because the wages of workers did not keep pace with production, leaving unsold goods and services and making necessary an absurd cutback in production. We will call this an "artificial recession" and it is the kind of recession that I think we can eradicate altogether.

When production increases with the same number of workers, that should make goods cheaper relative to wages. But business owners are naturally reluctant to raise wages or lower prices. In not doing so, they set the stage for recession. According the the law of supply and demand, prices should decrease or wages increase when production increases. When this is naturally resisted by business owners, a correction has to happen. Unfortunately, the correction comes in the form of a recession for the simple reason that it makes no sense to produce goods and service unless someone is going to buy them.

If wages and prices are balanced but there is a sudden increase in productivity, it will leave goods and services unsold. Business owners would naturally prefer to lay off workers rather than lower prices much and this feeds the recession. The market "tries" to strike a balance so that wages and prices are kept in equilibrium, but when this is resisted the correction must come from another direction, an absurd and artificial cutback in production, in other words a recession.

Thus I divide recessions into two categories, those brought about primarily by inflation and those brought about by the failure of the wage/price ratio to keep pace with production and so leaving goods and services unsold. Once a recession gets started, news feeds the downward spiral, people read that there is a recession and so hold back on hiring and spending and thus feeding the recession. Inflation and wages operate in a similar spiral that kills lending and investment.

In my theory, the reason behind the absurd and non-sensical artificial cutback in production that is a recession is the fact that our economy is not actually a true marketplace, even though we tend to think it is. A true marketplace involves haggling and negotiating over prices when a purchase is made. These traditional types of market continue in many places today. Rather than setting prices, buyer and seller haggle, or negotiate, the price. Even if there are price tags on goods, they are negotiable.

In such a traditional market, wages are not set either. Day labor (labour) is the rule. Workers and employers meet in the marketplace each morning, spend a few minutes negotiating the wages of a day's work and then are off to the task.

Our sacrosanct law of supply and demand originated in such traditional marketplaces. The reason that our free enterprise economy is not actually a true market is that the daily haggling does not take place. Wages and prices are set and are changed only reluctantly. Eventually, necessary corrections are made, but by then the recession spiral is already underway.

A haggling merchant would lower prices if demand were low that day. Day laborers (labourers) would make sure that their wages for a day's work will be enough for living expenses. This would self-correct the market and there would be no such thing as an artificial recession.

Our recessions happen because business owners today begin cutting back on production if they have to lower prices much. When production increases, they are reluctant to allow a corresponding increase in the wages that are necessary, on the whole, to purchase the goods and services. This resistance to the natural market forces means that the correction to maintain a balance must come from another direction, a cutback in production called a recession.

WEALTH DISTRIBUTION RELATIVE TO PRODUCTION

In my previous writings on economics, I have stated that the economy becomes "unbalanced". What I mean by this is the distribution of wealth among the wealthy and the non-wealthy relative to production. Most wealthy people make their money by selling to non-wealthy people. The vast majority of products and services are produced for sale primarily to the non-wealthy.

Since the money supply must be a mirror image of the goods and services produced, this means that there must be a correction if the distribution of wealth among the wealthy and the non-wealthy does not match the proportions of goods and services produced for purchase by each segment of the population. This correction will come in the form of a recession to eliminate the production of goods that will not find a buyer.

Most goods and services are what we will call "per person" goods. Their sale is in general proportion to the population, largely regardless of wealth. Such goods include cars, refrigerators, computers and, clothes. An average family may have one car, one refrigerator and, one computer. If they were to get rich so that their income was a hundred times as much, they will no doubt spend more. But they will probably not buy a hundred cars, a hundred refrigerators and, a hundred computers.

In America today 99% of the population, let's call them the "lower 99" owns only about 55% of the wealth. This is because the super-rich 1% own 45% of the wealth. The problem with this is that at least 80% of the goods and services produced by the economy are generally per-person goods and services. We expect the lower 99 to buy about 80% of the economic production but we only give them 55% of the wealth.

This is because the wealthy business owners have naturally tried to keep as much wealth as possible for themselves. This is not to blame them, making money is the whole rationale behind going into business. But if the money supply is a mirror image of the goods and serviced produced, 55% of the money cannot buy 80% of the goods and services. A correction has to come from somewhere and you know what it is, it's called a recession.

The flow of money between the wealthy and non-wealthy is the lifeblood of the economy. To the non-wealthy in the form of wages and to the wealthy in the form of prices. It is when this flow is hindered at any point that recession will result. It can be hindered by either the money supply to production ratio resulting in an inflation-induced recession or the production to wage/price ration resulting in a non-inflation-induced recession, when more money goes to the wealthy than comes back to the non-wealthy.

The last thing I want to do is to eliminate the wealthy or destroy incentive in any way but we must balance the production of the economy with those we expect to purchase what portion of the production. If the lower 99 are expected to purchase 80% of the goods and services that are produced, they must have 80% of the wealth or there will be the inevitable recession or maybe a crash. Increases in production must be balanced by corresponding increases in wages or some goods and services will remain unsold.

This is what we could refer to as "demand side economics", the wealth distribution must balance with the proportion of goods and services produced primarily for each segment of the population in terms of wealth.

You might say that "The market will sort all of this out". That is absolutely right, but unfortunately it does so in the form of a recession or maybe an all-out crash, which is what we are trying to eliminate from our economic future. Our recessions are brought about every few years by the law of supply and demand because we ignore this wealth distribution/production balance.

There is a reason that this is not more obvious: credit. It is possible to keep the economy running with the imbalance that I have just described and that is to get people living beyond their means by way of credit. This pervasive dependence on credit is a symptom of this economic imbalance just as are collection agencies. If there were no such thing as credit, this imbalance would be immediately obvious. Credit hides and delays the correction of the wealth distribution/production imbalance but this only means it will be more severe when it does come.

SUMMARY OF RECESSIONS

To summarize, the law of supply and demand arose from traditional marketplaces with haggling over prices and the wages for labor (larbour) on a daily basis. In our modern economy, the same principles do apply but the setting of wages and prices and changing tham only reluctantly means that ours is not as true of a market. The traditional market corrects daily so that there will be no such thing as an artificial recession, but since our economy resists wage and price changes, the correction comes from another direction in the form of recession.

This lack of daily correction by haggling and negotiating means that we must pay attention to another rule besides that of supply and demand because this does not take into account that the wealthy will naturally try to keep as much of the wealth for themselves as they can. This additional rule to avoid artificial recession is that the wealth distribution among the wealthy and the non-wealthy must match the proportion of goods and services that are produced primarily for purchase for each segment of the population in terms of wealth.

In the economy of today, some goods are produced for sale to the wealthy but this comes nowhere near matching the proportion of wealth that they get. The only way to bridge the gap and keep the economy going is by means of credit but this only delays the inevitably correction brought about by the market forces, which unfortunately comes in the form of a recession.

A basic flaw of capitalism is that workers are unable to buy all of the goods and services that they have produced while at work. This is because in a business-friendly environment, the wealthy tend to take as much of the wealth as they can for themselves. This leaves goods and services unsold because wages do not keep up with increases in productivity. The result is an artificial cutback in production, which we refer to as a recession.

Business owners resist raising wages as fast as production increases and would rather cut back on production if they must lower prices much due to decreased demand. This resistance is in contradiction to the forces of supply and demand so the correction comes from another direction, that of a cutback in production to balance the production with the supply of money available to buy the goods and services that have been produced which need not have occurred. The recession often has it's official beginning with a drop in the stock market but this drop always results from some underlying flaw in the economy.

There is so much that simply does not make sense about our economic system as it is. Wages simply do not keep pace with production because business owners naturally want to keep as much profit for themselves as they can. But this hinders the operation of the entire system because it leaves goods and services unsold and results in a needless cutback in production because it does not make sense to produce goods and services for which there will not be a buyer.

How many times do we have a family trying to keep an old car running that has outlived it's useful life because they cannot afford a new car while down the street a car dealership is laying off workers because sales are so slow? It does not make sense and the underlying cause is the lag of wages in keeping pace with production.

MANIPULATION OF INCOME TAXES AND THE MONEY SUPPLY

The truth is that if all business owners in the economy were forced to give employees a 50% pay raise they would, as a whole, get the money back because then shoppers would have 50% more money to spend. Such a tactic would eliminate large amounts of goods and services remaining unsold but business owners would likely raise prices due to increased demand and the tactic would just result in inflation if the increase in wages was not matched by an increase in production.

Another possible way to get more money into the hands of wage-earners to buy unsold goods and services resulting from an increase in production would be to link wages paid out and taxes for business owners. That is, if business owners would agree to give their employees pay raises, they would have their tax rate lowered. But such a system would be laborious and difficult for the government to verify.

Today, I would like to introduce my idea to prevent recessions by balancing the goods and services produced with the money available to buy them. It can be done without requiring business owners to give raises or any other process that is complex and difficult to verify.

There are two other variables in the economic equation that are readily under the control of the government, the money supply and the income tax on wage-earners. My plan is for the government to manipulate these two variables to keep the balance between goods and services produced and the money available to buy them.

Suppose, for example, that over the past year productivity of those goods and services that are usually bought by the average person has increased 7% but the wages of the people who are expected to buy these goods and services has increased only 2%. That could lead to a potential recession except for the use of credit, which as I pointed out is also a symptom of a seriously unbalanced economy. Under my plan in this situation, the government would increase the money supply by 5% and use the extra money to lower the income taxes on everyone earning a paycheck.

Workers would bring home enough extra money to balance the increase in productivity to buy essentially all of the goods and services that had been produced without their employers giving them raises. Business owners could produce and sell as much as they could as long as there was demand for it and government would bring in more tax revenue from business while not losing anything in lower income tax rates from wage-earners. The mints destroy used bills in incinerators and print new money to replace it so it can control the money supply at will.

Can you imagine what it would be like if we put together a balance sheet and income statement for the economy as a whole as accountants do for businesses? It would be horrendous. Only about 15% of workers actually producing any wealth, as I pointed out on this blog in the posting "The Extreme Inefficiency Of Wealth Production", poor coordination between wages and production that was covered up by extensive and unsustainable use of credit. No doubt the managers of such an enterprise would be shown the door immediately.

The Federal Reserve Bank in the U.S. manipulates the Prime Interest Rate, raising it to control inflation or lowering it to fend off recession. Why not maintain the balance between production and wages by manipulating the money supply and income taxes? The balance would not have to be perfect, keeping the gap between production and wages to within 1% or so should be acceptable and make recession just a word in history books.

VISCOSITY IN ECONOMICS

Here is another way of looking at my economic model.

Have you ever wondered why, as a society, we cannot just "do all that we can do"? For example, there is no shortage of building supplies so why can we not build a nice house for everybody? Instead, many people are living in sub-standard housing while builders do not have all the work that they could handle. This is due, plainly and simply, to the innate inefficiency in our economic system.

Today, I would like to discuss what I call "viscosity" in economic terms. Viscosity means the resistance to flow of a liquid. Oil has more resistance to flow than water and so oil is more viscous than water. Viscosity is a term that we usually associate with the oil in a car engine rather than with economics, but I will explain what I mean.

The basis of the concept is simple. It is any unmatched change in the productivity of an economic system that invites a recession as a correction. Suppose, keeping all other factors the same, there is an increase in the productivity of goods and services in the economy. This may sound like good news, but really it isn't. If, in a balanced economy, there is an increase in production while wages remain the same it will mean that there will be goods and services that remain unsold because there is not enough money earned as wages to buy them.

Since the vast majority of goods are produced for the average person to buy, business owners will begin considering cutbacks in production since it makes no sense to produce goods and services that will not sell. The result is that all too familiar word: recession. This just means an artificial cutback in production. Because this means laying off workers, who then have less money to spend on the goods and services that the economy produces, the recession forms a downward spiral.

This artificial cutback in production that we term a recession does not occur in traditional market places where haggling is done rather than fixing prices. That type of market has a fluidity that our modern marketplace lacks because any change in production or availability of goods is automatically corrected for in the haggling over prices.

In our modern market place, business owners strive to increase production but are reluctant to lower prices or to increase wages. Naturally, they want to maximize (maximise) profit because that is the reason they went into business in the first place. So, they decide to cut back on production when they find that they are producing goods or services that are remaining unsold and this feeds the recession spiral.

Thus, capitalism works against itself unless this can be corrected. The reverse is also true, maximum efficiency is like a peak that we can slip from to either side. if we pay workers the same when production decreases, we invite inflation and the recession that it can bring by sapping workers' buying power.

We can have a rightward recession by allowing the wealthy to take too much of the money for themselves. When this happens, it leaves workers without enough money to buy the goods and services that the economy expects them to buy since all of the money in circulation is a mirror image in value of all the goods and services that are produced. The result is goods and services remaining unsold and a cutback in production resulting in recession.

A leftward recession can result if the government spends too much money in relation to the goods and services that are produced. This causes inflation because this spending must "hitch a ride" on the goods and services that are produced and it drives up prices, meaning that workers can afford to buy less. Does anyone remember Britain's strike-inflation spiral of the late 1970s? In America, inflation reached 13% in 1979. We do not want this again.

It is clear then, that prosperity results not just from production but from "matched production". We want maximum production but workers must have enough money to buy all of the goods and services that are produced or it will only result in recession. Productivity is much more viscous, or changeable, than wages and prices so we lack the fluidity of a traditional haggling market place.

My plan is for the government to correct this viscosity imbalance by carefully manipulating two factors that it has control of. One is the currency supply and the other is income taxes. When there is an increase in productivity relative to wages, the government will increase the currency supply accordingly and use the extra money to lower income taxes so that workers will have all the money necessary to buy all the goods and services produces, leaving none unsold. This way, there is no reason that we cannot go on indefinitely increasing production and indeed "do all that we can do". Matched production is the key.

Deflation

We sometimes read of inflation as a threat to the health of our economy. But now there is the chance of a phenomenon that occurs much less often, that of deflation. This is, as the name imples, a drop in prices, the opposite of inflation. With such a sustained drop in prices, business owners are unable to make money and cut back on production.

Deflation was last seen on a large scale during the 1930s. The inevitable decline in our standard of living relative to the rest of the world unless the western countries develop enough new technology to balance the fact that so many goods and services can be produced more cost-effectively in the eastern countries. Deflation has the same economic effect as the increases in production relative to wages resulting in recessions that I described in "Recessions Made Really Simple" on this blog.

The way I see it, deflation is a symptom of exactly the same thing that causes recessions, consumers not being paid enough money to buy all the goods and services that have been produced. This means that the solution that I proposed in "Recessions Made Really Simple", manipulation by the government of the money supply and use of the extra money to lower income taxes on everyone earning a paycheck, can also be used to manage deflation, should it occur. It will get more money in the hands of consumers, without them actually being given raises, to increase demand.

Industry in the U.S. keeps closing and relocating offshore to produce goods that they expect to sell to consumers back home. But if industry keeps doing this, those consumers will not have enough money to buy those goods. The drop in home prices are deflation that is already underway. Home prices are dropping not because of a lack of demand for a place to live but because workers are not being paid enough money to buy the houses. When production increases, as it usually does, the government can help remedy this by increasing the money supply and using the extra money to lower income taxes.

Economic Collapse

Let's take a look at the growing financial catastrophe. (This was written in autumn 2008.) I find that there is an aspect of the collapse that is not being mentioned in the news. That aspect is the explosive growth of collection agencies in the U.S. during this decade.

We should have seen this collapse coming. What should it tell us when collection agencies, which buy bad debt at greatly reduced prices and call the debtor repeatedly demanding payment, are one of the greatest growth industries in the country? It should have told us that the economy is so unbalanced that the average person cannot afford to live.

The root cause of this collapse is millions of defaults on mortgages. About half the mortgages in the U.S. are bought by one of the two corporations created by the government to buy mortgages from banks and lending companies. These corporations are usually known by their nicknames based on acronyms, Fannie Mae and Freddie Mac. Mortgages are bundled into securities by the thousands and sold as bonds and other financial products. The idea behind this system is to get money to the lending institutions that can be loaned to other home buyers and thus increase home ownership in the country.

The trouble begins with the severe imbalance in the economy during this decade. The rich got richer at the expense of the average person. By one estimate, over 40% of the wealth in the U.S. is owned by the richest one percent of the population. Even though productivity in the U.S. has greatly increased in recent decades the wages of the average person, adjusted for inflation, have decreased.

So what happened is that while millionaires were becoming billionaires, the average person had great difficulty paying their mortgage. Since mortgage-backed securities are such an important part of the economy, this has brought the entire economic structure to the brink of collapse. The explosive growth of collection agencies since the beginning of this decade should have told us that this is coming. I wrote this in an email that circulated several years ago.

While the rich were getting richer, there were more and more articles about the "working poor", people who have jobs but must choose between paying the electric bill or buying food. Tens of thousands of people were working full time but living in homeless shelters because they could not afford to live on their wages. The basic agreement of civilization is that if a person works full time, that person will be able to afford to live. We have broken this agreement and now the result is this catastrophe.

The economic structure of society is shaped like a pyramid. It requires the spending of several hundred wage and salary earners and small business owners to support each millionaire in the economy. The upper reaches of the pyramid depends on the lower part for support, likewise the more money the average person has, the more secure the wealthy will be.

Suppose a ship is carrying a cargo of steel. The lower the center of gravity of a ship, the more stable it is, which is why ships carry ballast. Now suppose we take large amounts of the steel cargo and place it higher on the ship. It would make the ship more vulnerable to tipping. The economy operates in the same way and when it crashes, the wealthy at the top of the ship have the furthest to fall.

This is not the first time this has happened. In the 1920s, factories across America were booming. The trouble was that they were paying their workers as little as possible in order to maximize profits. This meant that there were not many people who could afford the array of mass-produced products that came off the assembly lines and they began piling up in warehouses. Factories began cutting back on production, meaning that workers had even less money to spend and, it spiraled into a devastating crash.

Why should there ever be a recession or depression? If our population and productivity are continually increasing, there should really never be a decrease in business activity. Recessions are caused by a lack of spending by the average person. When people are walking around with money in their pockets, there will never be a recession.

It is not so much that the average person is not earning money but that they are loaded down with so much that they have to buy to live. This can only be caused by the unfair and unequitable distribution of the nation's increasing wealth. There has been a greatly-increasing number of billionaires while so many average families are $50,000 or more in debt, not from buying luxuries but from spending on the basic necessities of life. Eventually, the entire economic structure becomes unsustainable.

The profit motive results in the short-term thinking that as long as people are making money, everything will all work out. Underlying this mortgage mess was the assumption that property values will keep on increasing forever, this caused developers to over-build, which then caused property values to plunge, according to the law of supply and demand.

Capitalism creates wealth but the whole structure is so fickle and precarious. The rating agencies such as Moodys and Standard and Poor have a great ability to influence the economy, their recently downgrades of AIG (American Insurance Group) and General Motors sent the market into a tailspin each time. Another factor that I have pointed out in another posting on this blog, "The Extreme Inefficiency Of Wealth Creation" is that only about 15% of the workers in the economy actually create any wealth when they go to work. "Wealth" is created too much by moving paper around instead of actually producing something.

One factor that we tend to gloss over if the effect that events such as this has on the entire world. America was booming in the 1920s and only a few intellectuals in the west even knew what Communism was. The Crash of 1929 changed all of that and Communism, which never should really have been a major world system, began to be seen as the way of the future. The crash devastated the economy of Germany worse than the U.S and out of the chaos arose the Nazis.

In the 1990s, America had not only a balanced budget but a surplus and managed to avoid the currency crisis that afflicted much of the rest of the world. But under this Republican administration, America is the source of the calamity that has now hit and is so in debt that if it suddenly had to repay all the money owed to Japan, China and, Britain the economy would certainly collapse. The one thing that is worse than taxing and spending is spending without taxing in order to get way into debt.

How does this system look to the world when we are trying to promote our style of democracy? It just looks like the wealthiest people create ever-more complex derivatives and other financial products to outsmart government regulators. Over-complex financial products were a factor in the 1929 crash as well.

The simplistic Republican idea of free-wheeling capitalism was what the country needed in it's early days of the frontier. People were needed to get out there and start farms, business and, industries to build the country. The book "The Wealth of Nations" by Adam Smith is the original foundation of Republican ideology, but it was written in the Eighteenth Century. Society is much more complex today and someone cannot just head out to the frontier and start over when there is an economic downturn.

But Republican ideology has not yet caught on and you may have noticed that the economic crashes of 1929, 1987 and now 2008 all came after an extended period of Republican presidential leadership. Republican capitalism today is certainly at the same point as Communism was during the 1980s. If there is one thing we should be thankful for it is that this crash happened before the election rather than after it.

The strength of the Republican Party was always in peripheral issues rather than the core issue of politics, which is economics. Republican economics was beneficial only in the early days of the country and later when the economy had gone too far leftward and there was a pressing need to cut excessive spending and curb inflation. Other than that, their economic performance is generally poor. Even on peripheral issues, they vociferously denied global warming for years and now that it is impossible to deny, they have switched to saying it will actually be a good thing for the world.

If you think this private health care system is the best, consider that America spends far more per person on health care than any other country but U.S. male life expectancy is not even in the top thirty in the world.

An unfortunate thing about politics is that campaigning in an election and running the country after being elected requires two very different sets of skills. One ideology or party may be better at gaining power than another but not as good at running the country once actually in power. Republicans have this in common with Communists, they are much better at gaining power than actually running a modern economy once in power. Republicans have a way of making people think they are not patriotic unless they are Republican, that an American is "supposed" to be a Republican, that free-wheeling capitalism is the "American way" even though no such thing is written in the constitution. The average person is the one who ultimately pays.

I am the last person who wants to stop enterprising people from making money. But when money equals power, those who have a lot of it tend to set things up to suit themselves. People making money tend to want to keep it that way and it becomes a roadblock to progress.

The roadblock to health care reform is the fact that the private insurers are making so much money. One reason that there is not enough money in the U.S. for a national health care system and other social programs that the other western countries have is that resources are in private hands. Many countries pay for most of their health care from income produced by natural resources. Private companies may manage the production of such resources but the resources themselves belong to the country.

A mixed economy can counterbalance the effects of capitalism. Many areas of the U.S. grow rich but do so only at the expense of places like Buffalo and Detroit. When many people leave a given area, the declining population that remains will have to pay higher taxes in order to support the infrastructure that was designed for a larger population and these taxes will encourage more people to leave and discourage business from moving in. Governement involvement in the economy can provide a counterbalance by investing in the many such left-behind areas.

I pointed out in my writing about a mild form of socialism for America "Power At The Center" in my book, "The Patterns Of New Ideas" that capitalism alone does a poor job of providing low-cost housing. This is because most developers would rather deal with commercial buildings or more expensive homes. Low-cost housing often has a long waiting list. People buy houses that maybe they could not afford simply because they must have a place to live. If there was abundant low-cost housing available or if the tremendous wealth produced in America was distributed more equitably, this collapse would not have happened.

It is frustrating to know what is happening but not being able to get the powers-that-be to listed, almost a year ago, I wrote in http://www.markmeekobs.blogspot.com/ that this mortgage crisis was in danger of becoming an economic collapse.

Economic Boom And Bust Cycles

Today, I would like to introduce more of my economic theory. Today's posting concerns the destructive boom and bust cycles that plague the economy. When I landed in the U.S. as a child, there was a large open field nearby and one of the first things I did was to look around that field. I found several pieces of wood that were of similar length and attempted to construct a tepee like one of the ones that I had seen on television.

Now, I consider such a tepee as an ideal model of a modern ecomomy. This type of structure consists of several lengths of wood placed upright with one end on the ground so that they meet and can be tied together at the top, forming a cone-shaped structure. Cloth or animal skins can be placed around the outside of the structure for warmth and protection from the wind and rain. When it comes time to move, the structure can be easily dismantled and transported to a new location.

INDEPENDENT AND DEPENDENT SECTORS OF THE ECONOMY

Now think of the different sectors of the economy today. There are what I will call the "independent sectors" and the "dependent sectors". The independent sectors of the economy revolve around basic necessities that we cannot do without and will always require. These are primarily food, clothing and, housing.

There are, as I see it, many more dependent sectors. There are the ones that are not as absolutely necessary to life as the dependent sectors. These include computers, communications, transportation, the military, education, government, finance, entertainment and, sports.

The purpose of this posting is to convey my explanation of the economic "bubbles" that grow and cause financial havoc when they inevitably burst. This is one of the great drawbacks of capitalism, it's perpetual boom and bust cycles. This explanation involves the same type of logic that I presented in the posting "Recessions Made Really Simple" on this blog.

The danger begins when one sector of the economy begins growing at a much faster rate than the other sectors. This is not always a bad thing as long as it is caused by genuine progress. The truth, however, is that artificial booms are usually driven by a mad rush of investors to what they perceive as the latest hot new thing.

We must remember that one sector of the economy, as a proportion of the economy, can only grow at the expense of the other sectors. When investors put more money into one of the sectors than is justified by genuine technical or social progress, we get a distortion in the economy that we commonly call a "bubble". When this happens, sooner or later it tends to burst.

An economy is most stable when all of it's primary sectors grow together, at least in proportion to genuine progress. Investors, anxious to get in on a quick money maker, do not take this big picture into account, with eventually catastrophic results. There has been more than one real estate bust caused by the concept that property values will go on rising forever without stopping to realize that for this to happen, workers in the other sectors of the economy that are the ones buying the properties would have to have their earnings increasing that the same rate that the property values are increasing.

This means that for property values to go on increasing indefinitely, the other sectors of the economy must also be increasing at a similar rate. If this is not happening, the workers in these other sectors will not have enough money to keep driving up property values and sooner or later, those values must return to realistic levels.

I want to introduce the concept that, while these destructive bubbles can occur in either the independent or the dependent sectors of the economy, they do so for different reasons. There will always be the economic sectors that produce and market the basic necessites like food, clothing and, housing. The most important factor limiting the growth of these sectors is the income of people as a whole.

Put simply, all people require food, clothing and, shelter. But if someone were to suddenly increase their income by a factor of three, they probably will not buy three homes, instead of one, three times as much clothes and, three times as much food. Rather, they will tend to buy similar amounts of these goods but of higher quality.

Thus, growth of the independent sectors of the economy will focus on quality, more than quantity, and the limiting factor of this growth is the income of workers in the other sectors of the economy. The independent sectors must exist because they represent basic necessities but are constrained from growing faster than the dependent sectors.

FUNDAMENTAL IMPORTANCE

To describe the inherent limits on growth in the dependent sectors of the economy, I would like to introduce a concept that seems vital to me. To avoid destructive bursting of bubbles in the future we must remember that the dependent sectors of the economy, which produce and market goods and services that are not absolutely necessary to life, have a certain "Fundamental Importance" to the economy as a whole.

When investors rush to a certain dependent sector of the economy, they risk pushing the money in that sector beyond that amount which is proportional to the sector's fundamental importance. This will inevitably result in a boom and the inevitable bursting of the resulting bubble.

There is no better example of this than the Dot Com Bust in 2000. Windows 95 did wonders for the computer sector and investment poured in throughout the late 90s. The trouble was that it was not matched by that sector's fundamental importance to the economy. Of course computers are here to stay, but we tried to push too far, too fast and the result was the bust.

ECONOMIC RULES OF FUNDAMENTAL IMPORTANCE

Here are my rules of logic concerning the fundamental importance of the dependent sectors of the economy. Destructive bubbles in the economy result when investment pouring into one of these sectors is out of proportion to it's fundamental importance.

Computers can do wonders. But we must not forget that the purpose of computers is to manage information. Therefore, the subjects which the computers manage information about must necessarily be considered as more important than the computers themselves. It would not make sense to build a sector of the economy to manage information about other sectors unless those other sectors were more important than the sector that was constructed to manage information about them. Thus, an economy with computers as it's most important sector makes no sense.

The communications sector relays information. But the sector that relays information about the other sectors must necessarily be considered as of less fundamental importance than the sectors that it relays information about. It does not make sense to build a sector of the economy to relay information about other sectors of the economy unless those other sectors are considered as fundamentally more important than the sector that relays information about them. Thus, an economy with communications as it's most important sector makes no sense.

The purpose of the transportation sector of the economy is to get us from Point A to Point B. This must mean that the fundamental importance of this sector must be less than those sectors whose activities take place at Point A and Point B. Thus, an economy with transportation as it's most important sector makes no sense.

The purpose of the financial sector of the economy is to extend credit to the other sectors. This means that it must necessarily be considered as less important than those other sectors and an economy with finance as it's most important sector makes no sense.

The purpose of the educational sector of the economy is to provide the knowledge and training necessary to the other sectors of the economy. Therefore, it must be considered as inherently of less fundamental importance than those other sectors and an economy in which education is the most important sector makes no sense.

The purpose of the health sector of the economy is to keep people healthy so that they can work efficiently in the other sectors of the economy. The purpose of the military, law enforcement and judicial sectors of the economy are to protect the people working in the other sectors of the economy. The purpose of the government sector of the economy is to administer the other sectors so that they can operate at the best efficiency. The purpose of the entertainment and sports sectors of the economy is to entertain people who work in the other sectors during their free time. Therefore, an economy with any of these sectors being considered as it's most important makes no sense.

You can see how the different sectors of the economy very must resemble several lengths of wood places together to stand upright. The stability of the structure would be compromised if one of the pieces were to grow disproportionally to the others. As long as the sectors grow together, there are practically no limits to growth. By keeping this in mind, we can avoid the destructive boom and bust cycles that have plagued the idea of free enterprise.

The Extreme Inefficiency Of Wealth Production

In my book, "The Patterns of New Ideas", I discussed the idea of what I called "fluff" in economic terms (see the idea "Power at the Center"). Fluff is what I termed the tens of millions of people who work hard every day at jobs that often require a great amount of skill and education but produce no wealth at all. The very idea of labor (labour) is to create or increase wealth.

The reason that so many workers produce no wealth at all is not any fault of their own but to the inefficient nature of the economic system itself. I should state now that this article is not political in nature and is no endorsement of either right or left, conservative or liberal. Accepting that the whole idea of working is to create or increase wealth, it does not seem to me that many workers are doing it just for fun, the thing that I find absolutely shocking about society is that so very few workers actually produce any wealth in their daily work.

A downside of a free economy that we tend to ignore is the drift toward the creation of jobs that do not produce any wealth themselves but make it possible for others to create the wealth needed for the society to survive. Have you ever stopped to wonder how many people actually create any wealth while doing their jobs? My guess is that it is probably no more than about 15%.

I have divided all workers into four categories. 1) Those that make things. 2) Those that fix things. 3) Those that move things. 4) Those that run things.

Of these categories, the only workers that actually create wealth is the first and second categories, but the first is more important than the second. Keeping in mind that many jobs fall into more than one category, the vast majority of workers, at least in the western countries, fall into the third and fourth categories, which produce no wealth at all.

Suppose a new island was discovered and the best workers in the world from a variety of occupations was chosen to build a society on the island. Chosen were the best judges, lawyers, police officers, firemen, mailmen, sales people, politicians, soldiers, cashiers, customs officials and, security guards. What would happen?

The answer is, of course, that they would all starve because none of them is producing any wealth. It is the wealth produced by a few workers that the entire society depends on and the others, no matter how capable they may be, are only in a support role. This is a fact that I have noticed we tend to lose sight of as society gets more and more complex. In fact, I would say that the proportion of support workers in the economy is proportional to the complexity of the economy.

In a simple farming village of centuries past, almost everyone is producing wealth. But as the economic sphere grows in geographic size, an increased proportion of workers is required to be moving things rather than making things, thus decreasing the economic efficiency. The problem with a more complex economy is that the complexity must be managed by labor (labour) and brainpower, thus diverting workers away from the primary task of wealth creation.

The increase in complexity was most likely brought about by improvements in technology and the fact we tend to ignore is that the management of the new economic complexity diverts workers from actual production and thus hinders the improvements in production brought about by the new technology. A free economy really opens up the creativity of individual workers but lacks the oversight to control the drift toward the inefficiency that comes from having so few workers actually producing wealth.

The picture is not quite this simple. It is great to have the maximum number of workers actually producing wealth but all wealth is not created equal. I have divided the wealth that is actually produced into "necessary wealth" and "artificial wealth". In fact, in my economic theory I define artificial wealth as a lesser form of fluff. Although it is usually preferable to have workers producing some kind of wealth than no wealth at all, we do not want overproduction of any kind.

The most obvious examples of necessary wealth are food, clothing, shelter and, education. I do define information as wealth and so it is being created by these writings. An example of artificial wealth is cars. We need cars but only because society has been set up so that cars are required. Wealth can be defined as artificial if the need for it could have been avoided and as necessary if it could not.

In the world today, there is so much knowledge and so much potential for productivity yet so much poverty. Part of the reason is the incentive factor in markets that are less than free but the other part is that in free markets, there tends to be a very limited number of the total workers actually producing any wealth. Complexity must be managed by labour (labor) and brainpower so the more complex the society, the lower will be the proportion of workers actually producing any wealth. One flaw of free enterprise that usually gets overlooked is that it takes no account of this.

There is so much talk of "creating jobs" and that is all well and good, but jobs doing what? When jobs are created, how much wealth is being created? Some degree of central oversight of the economy can reduce the unnecessary complexity of the economy to divert more workers and brainpower to actually creating wealth.

The Production Tier

Have you ever been in a car with several people on the way to some destination when, while you all agree on what the destination is, everyone has a different opinion on the best route to get there?

Well, economics is the same way. Some say that the best way to get to where we want to be is free-market capitalism, others lean toward communism, while the rest fall into the various shades of socialism in between. With all of our wrangling about the best route to take, we have badly lost sight of what the destination itself should be.

Today, why don't we put aside all of the usual route-based thinking concerning economics, all of the debate about capitalism, socialism and, communism, and refocus on our destination?

Remember that terms like communism and socialism are from the Nineteenth Century. At the time, the vast majority of workers were engaged in work that actually produced something so that the bloat in non-productive workers in the economy that I described in "The Extreme Inefficiency Of Wealth Production" , on the economics blog, was not yet an issue.

Have you ever wondered why since productivity has drastically increased over the past few decades, most people are hard at work, we have more knowledge than ever yet, there is so much lack and want?

Part of the reason is that we have drifted into a situation in which only a relative few are engaged in work that actually produces anything tangible. There is much talk about "creating jobs", the question is: "jobs doing what"? Our economy is designed for efficiency on a local scale, but is highly inefficient on a large scale because one of the weaknesses of the free market is that it lacks big-picture, long-term thinking, and this is the result.

Suppose that there was a factory owner who had hired the workers he would need to operate the factory. Some workers would be production workers inside the factory, while others would be drivers to get the finished goods to market and sales people to bring in new orders.

Wouldn't it be logical to have only as many workers as necessary working as drivers and salesmen, so that the maximum number of workers can be actually producing goods? Why don't we have this vision for the economy as a whole?

The way I see it, there is a "production tier" of workers. I have referred to this in previous postings on economics. All workers are not created equal, the tier is as follows:

1) Those who make things. This includes researchers, non-fiction writers, programmers and, education workers, because I define knowledge as wealth.

2) Those who fix things. This includes medical workers, mechanics and all emergency workers.

3) Those who move things. This includes salespeople, merchants and, all who facilitate business connections.

4) Those who run things. This includes politicians, management, the military and, legal workers.

I define our fundamental goal as having as many workers as possible as high as possible on the tier, regardless of what "route" we take to get there. These "routes", like capitalism, communism and, socialism should not be ends in themselves, but only means to ends. We have lost sight of this production tier simply because at the time economics was broken down into these rival systems, the vast majority of workers were engaged in actual production.

Of course we need those workers in the lower tiers, I am not stating that we should scrimp on them in any way. But our goal should be to have only as many workers as necessary there so that as many workers as possible can be engaged in actually producing wealth. One factor that hides the production tier is the fact that the most powerful people in society are actually on the lowest tier.

This certainly does not mean production just for it's own sake. It means production of those goods that are real needs. To do this, we obviously need a continuous flow of new ideas to balance increases in productive efficiency so that the maximum number of workers remain in productive work.

I say that when it comes to economics, there is really no substitute for actually making things. An economy based on actual production of goods that people really need is always more secure and stable than an economy based on moving paper around.

Notice how, in the recent economic downturn, China was virtually unaffected and Germany was shown to have the most stable economy in Europe. The reason is that the economies of both countries are based on actual manufacturing. Tourism is very fickle as a source of income and resources are vulnerable to fluctuations in demand and prices.

What about national security? Isn't a country really more secure if it is capable of making and growing all that it needs, if necessity demands?

So, we can say that politics made really simple is based on paying workers the right amount relative to the work that is being done. Pay them too much and it just equalizes in the form of inflation. Pay them too little and it does not leave enough money available to buy all of the goods and services being produced in the economy, leading to a cutback in production and a recessionary spiral.

Now, we can add this production tier to basic politics and economics. Get as many workers as possible as high on the tier as possible, but they must be producing goods that there is a real need and demand for.

This is related to the concept of "fundamental importance" that I outlined in the posting "Economic Boom And Bust Cycles" on this. When investing in a given sector of the economy, it must be remembered that some sectors are dependent on other sectors and we only create a "bubble", that will eventually burst, when we invest so much in one sector that it upsets this balance.

The Wage And Price Disparity

One of the most important factors in the global economy today is the fact that in some countries, both wages and prices are high and in others both are low. I have yet to see a satisfactory answer as to why this is the case because I do not think that it can be due to inflation alone.

Inflation can certainly result in an upward wage-price spiral but when it does, the national currency becomes devalued relative to that of other countries which are not undergoing the same inflation. This means that inflation cannot really account for why wages and prices, in terms of real earnings, are so much higher in some countries in comparison with others.

The reason that these differences in wages and prices from one country to another are so important is very clear. Tens of millions of jobs have been lost in the high wage-high price nations of the west as production work and industry has migrated to those countries where workers are able to live on low wages because prices are also low. Today I would like to give my explanation of why, in our global economy, there is such differences in wages and prices.

First, let's consider why prices tend to be higher in cities than in most small towns and rural areas. The reason is that since land is more scarce in the cities, it's cost will naturally be higher. This means that for a business to buy or rent a building in a city, it will have to pay more than if the same building were in a rural area. The cost of the land that the building lies on finds it's way into the goods or services that the business manufactures or sells.

Since this is true of all the buildings used by all of the businesses in the city, it means that those workers who live and work in the city will have to pay more for things they buy than they would if they lived in rural areas. Thus, in order to keep workers, businesses in the city generally must pay more in wages than those in rural areas. The final result is that both wages and prices tend to be higher in cities than in rural areas.

I find that it is a similar principle which causes the wages and prices to be much higher in some countries in comparison with others. On this blog, there is a posting entitled "The Extreme Inefficiency Of Wealth Production" This details how we have gotten ourselves into a situation in which only about 15% of all workers actually produces any wealth when they go to work. This posting was a continuation of the idea of "fluff" that I introduced in my book "The Patterns Of New Ideas".

The basic purpose of working has always been to create wealth. It does not make much sense to work all day unless it produces something beneficial. But problems begin when technology comes along and makes production more efficient.

Suppose it requires ten workers to accomplish a certain task in the production of goods. Now suppose that a new machine is invented that makes it possible for only two workers to do the work that formerly required ten. Those eight workers that were made redundant will now have no source of income and so will be unable to afford the goods that are being produced. This will mean that it will not make economic sense for the two workers still employed to produce the goods because there will now be few people that are able to afford them.

(You can see that this rationale uses the same logic as the posting "Recessions Made Really Simple" on this blog. When there is an increase in production without a corresponding increase in wages, there is not enough money in circulation to buy all the goods that have been produced and an artificial cutback in production is the result.)

As new technology comes on the scene some of the eight displaced workers find their way into the production of new types of goods, such as making the new machines that the original two workers now use to make their goods. However, a basic problem with our economic system and our society is that while new technology both creates and eliminates jobs, it usually eliminates jobs faster than it creates them. If this were not true, there would be no such thing as unemployment (redundancy).

Basic common sense tells us that it is of no use to create a machine that can enable two workers to do the work that was formerly done by ten if it requires eight workers to build and maintain the new machines. If that were the case, no jobs would be eliminated but the factory owner may as well just leave things the way they were originally, since he would have to pay for the new machine but would not be saving any money on wages. Society could not function if technology put most workers out of work unless it could make a communistic system work without destroying enterprise and initiative.

The result is that the economy tends to create all kinds of work that employs the majority of workers but does not actually produce any wealth. This is what I was referring to in my previous writing on this subject. Without these tens of millions of non-production jobs, the production itself would make no sense because few people would have the money to buy the goods. If the means of production in an economy is too efficient, it will tend to create enough non-production jobs so that it can remain near peak production.

Now, let's move on to the basic economic principle that all of the wages, salaries and, profits in an economy must match all of the prices paid. The vast number of workers whose work does not actually produce any wealth must be paid wages just as do those who do produce wealth. If any workers are not paid enough, the production sector will not be able to operate at peak production because there will not be enough people earning enough money to buy all of the goods. This must mean that the wages of the majority of workers that do not actually produce any wealth when they go to work must "hitch a ride" on the prices of the goods that are produced by a relative few of the workers.

Let's now go back to why there is such wage/price disparities from one country to another that there is a mass movement of industrial work and other jobs from one side of the world to the other, the phenomenon commonly known as "outsourcing". I would like to establish the economic principle that the prices of goods and wages in an economy is determined not by the technical efficiency of production but by the proportion of workers in the economy engaged in non-production tasks.

My hypothesis is that if a high proportion of workers in an economy are engaged in acutal production of wealth both wages and prices will be relatively low, regardless of the inefficiency of that production. In the same way if only a few workers actually produce wealth, even if very efficiently, prices and wages will necessarily be high.

This explains why prices tend to be high in prosperous countries. The wealth production system is so efficient that it requires only a fraction of the total workforce and the wages of the others must "hitch a ride" on the goods that are produced.

Simple logic would seem to dictate that as efficiency of production increases, the price per good should get lower. But we can now see why this is often not the case. We can also see why industry tends to migrate across the world to countries with lower wages.

The great paradox of our global economic system is that if a country manages to increase the efficiency of it's wealth production, it will drive industry away instead of attracting it. A spiral gets started in which some production leaves for offshore locations, meaning that there will be more workers engaged in non-production tasks, meaning that wages and prices will rise, meaning that yet more production work will leave.

This is simply because increased production efficiency will mean more workers who do not actually produce any wealth but whose wages must "hitch a ride" on the prices of the goods that are produced. We can also see why wages and prices were so much lower in the past, many more workers were employed in production.

There is one way around this. I described it in the posting "The Idea Curve" on this blog.

Suppose that in our simple example of the ten workers, there was a never-ending flow of new ideas into the economy. The eight redundant workers would find their way into the new industries that were continuously being born. If we were able to keep in front of the Idea Curve, unemployment would virtually cease to exist. We could also lower the proportion of workers engaged in non-production work so that industry would have less reason to move offshore.

The fact that there is unemployment and a majority of workers employed in non-wealth production means that we are behind maximum efficiency in the Idea Curve. The economy of the western countries is a lot like an airplane (aeroplane). The plane must keep moving to remain aloft. If it tries to stand still, or moves too slowly, it will lose altitude.

The trouble with making production more efficient is that it leaves many workers with no way to earn the money to afford the goods that are produced. One solution is to develop a vast number of jobs that do not actually produce wealth, but that drives up wages and prices and prompts industry to move offshore. A better solution is an increase in the flow of new ideas and new technology in which workers in those industries will be producing actual wealth. This was the reason behind two of my books, "The Patterns of New Ideas" and "The Commoner Syndrome".

All of the facets of my economic theory operate by the same idea of balance. All wages and salaries paid in an economy find their way into the cost of living. In a balanced economy, we invite recession if the wealthy take too much of the wealth for themselves because it will not leave enough money in circulation to buy all of the goods and services that are produced in the economy.

If we try to grow one sector of the economy in a way that outstrips genuine progress, it will just form an artifical bubble that bursts, as I described in the posting on this blog, "Economic Boom And Bust Cycles" . And now we can see that if we make the production of wealth efficient without a corresponding flow of new ideas, we will only drive industry offshore by scaling up wages and prices.

The Wage-Price Spiral Made Really Simple

In western countries, both wages and prices tend to rise over time even if the average buying power remains about the same. When I was old enough to begin working, minimum wage in New York State was US$2.35, but then the price of gasoline was nowhere near $1 per gallon. What is the point of wages and prices continuing to rise over time if they remain similar in comparison to one another so that there is no real change in buying power?

In the posting "The Wage And Price Disparity", I explained that the reason both wages and prices are high in some countries while both are low in others, is related to the proportion of workers in the economy that are engaged in actually producing something.

In another posting on this blog, "The Extreme Inefficiency Of Wealth Production" I pointed out that only a small proportion of workers in western countries actually produce something when they go to work. When a significant proportion of workers do work that does not actually produce something, both wages and prices will tend to be higher.

If a majority of workers in an economic system are working at actually producing something, both wages and prices will be relatively low. This is because factory owners will naturally want to pay their workers low wages in order to maximize profit. But if most workers work in production, and therefore earn only low wages, they will not have much money to spend on the goods that they work at producing. This means that the price of the goods will have to be low as well, or else they will not sell.

Suppose that there is some type of breakthrough in the productivity of the goods so that instead of, say, 80% of workers working at actually producing something, now only 40% of workers are required to produce the same amount of food and manufactured goods as before. The redundant 40% cannot be allowed to be idle, because if they are not earning wages then they will not have the money to spend on goods, as they did before, and the system will go into recession.

The redundant 40% will end up as service workers in some capacity. This sector will offer useful services: lawyer, financial adviser, beautician, etc. but will not actually produce anything tangible. The workers in this non-production sector will depend on the spending of workers in the productive sector. Money paid to the workers in the non-productive sector will then be used to buy both the tangible goods and food of the productive sector, as well as the services of the non-productive sector.

Here is my principle concerning the relationship between productive and non-productive work in an economy: Those sectors of the economy that produce goods or food must directly or indirectly pay all of the wages of workers in the non-producing sectors. We could refer to the two as the "tangible" and the "intangible" sectors. It is the productive sector of the economy that came first, and is the "primary economy". The non-productive sector came later, and can be referred to as the "secondary economy".

The money in circulation forms a mirror image of the sum total of goods and services being produced. The value of a unit of currency primarily depends on the amount of money being printed relative to the total production.

Now that we have 40% of the workers engaged in the "secondary economy", we have more total goods and services being produced to be sold. To avoid deflation, more currency is called for. Since we still have the same total number of workers, this means that each worker in the economy will have to be paid more in order to support the new services being offered by the secondary economy.

Remember that the economy does not "know" exactly how much pay workers, as a whole, must get in order to be able to afford the new services being produced. The economy operates by trial and error and only "understands" absolute value, the total volume of goods and services sold and the relative pay of wages and salaries. When the now-rising wages paid out in the economy reach the point at which the economy is balanced, meaning that the total earnings and profit is just enough to buy all of the goods and services produced, the total wages, salaries and, profits do not "know" enough to stop increasing.

So, the economy seeks equilibrium by raising prices, according to the law of supply and demand. When equilibrium is reached, wages and prices have both increased. A primary reason for this spiral is that this inflation is anticipated and many workers get raises and cost of living adjustments automatically, making it a self-perpetuating cycle.

The process of innovation, which enables the same amount of goods to be produced with fewer workers, is an ongoing process so that as fewer workers are engaged in actual production, both wages and prices continuously increase. Therefore, my hypothesis is that the combined increase in wages and prices over time is a direct function of the decrease in the number of workers engaged in work that actually produces something tangible.

This does not mean that it is necessarily "bad" to have a lot of workers engaged in non-production work, the services provided are valuable and enhance the quality of life. However, the secondary economy will drive up both wages and prices in the economy as a whole, so that production work will tend to migrate to countries with a lower wage-price index which, of course, will feed a spiral in the first country by driving up both wages and prices even more.

This is just one of the conundrums of the free-market system.

The Healthy Economy

We can describe an economy as a platform to reward wealth creation and to make possible a division of labor (labour), so that each person just works at what they happen to be best at. This is accomplished by facilitating the intersection of the two sides of the economy, supply and demand.

Unfortunately, things do not always operate smoothly in the economy. The ideal is for the economy to make it possible so that we can just "do all that we can do" or in other words, reach our wealth-creation potential.

But what exactly is the exact difference between a healthy and an unhealthy economy? I would like to present my concept of what differentiates the two.

The vital difference lies in what we will refer to as "spirals" in the economy. A healthy economy is one that is free of these destructive spirals. A healthy modern economy turns out to be a lot like the wing of an aircraft in flight. It is desirable to have a smooth flow of air over the wing, rather than eddies and turbulence.

A healthy economy is balanced between it's supply and demand sides. Spiraling begins when we upset this balance by trying to expand either the supply or demand side, realtive to the other.

The first destructive spiral is the inflationary spiral. This gets started when we expand the demand side of the economy, relative to the supply side. In other words, moving too far left by paying out too much money relative to production. This imbalance simply corrects in the form of inflation. But then workers, seeing that their buying power has diminished, demand raises and cost of living adjustments, often by going on strike. This means paying out still more money, relative to production, and we have an inflationary spiral underway that is difficult to break, except by recession.

The second destructive spiral is the recessionary spiral. When supply is not matched by demand, the balance of the economy is again upset. This imbalance can be caused by an increase in production without a corresponding increase in wages, or by real wages being reduced by inflation. This would mean that goods and services would remain unsold. Since it does not make sense for companies to produce any thing that is not going to sell, they tend to cut back on production for a while. But this means that workers are let go and so have even less money to spend, furthering the spiral.

There can be a wage-price spiral for another reason. I described this in detail in the posting "The Wage-Price Spiral Made Really Simple" on this blog. When production of actual goods becomes so efficient that fewer people, relative to the work force as a whole, are working at actually producing something, this tends to drive up both wages and prices. This is because, as I described, the wages of the non-production workers must "hitch a ride" on the production sector. This spiral is caused by an increase in production efficiency without a corresponding increase in new ideas, so that a decreasing proportion of workers actually work at producing something. This spiral is destructive because it drives production work to other countries where prices are lower.

The fourth destructive spiral is represented by the so-called "bubbles" that appear in the economy periodically. I have described this in detail in the posting "Economic Boom And Bust Cycles" on the economics blog. This spiral takes place when there is a rush of investment to a given sector of the economy, such as housing. This causes prices to rise in that sector and other would-be investors, expecting prices to continue to rise, are also drawn in, causing prices in that sector to rise even more. But as I explained in "Economic Boom And Bust Cycles", there must be a balance between the various sectors of the economy based on what I referred to as "fundamental importance". This balance is similar in concept to, but separate from, the essential balance between the supply and demand sides of the economy. Put simply, we cannot enlarge one sector of the economy out of logical proportion to the others. When we do, we end up with a bubble that will, sooner or later, burst. There are only two real ways to expand the economy, more people as workers and consumers or more ideas for production, which must be balanced by wages.

The fifth destructive spiral is the wealth spiral. Money inevitably equals power. The risk is that those with money will use their power to set things up so that still more money flows their way. The wealthy are important to the economy because it is they who tend to start new production. But if too much money, relative to the total supply, is in the hands of the wealthy, this means less in the hands of the average consumer. Since most products are made for the average consumer, and the wealthy do not spend as high a proportion of their total wealth on the goods and services that the economy produces, this can only mean that there will be production that remains unsold because consumers could not afford it, and this leads us to our recessionary spiral.

Finally we have our sixth destructive spiral, the poverty spiral. The strange, and sad, thing about being poor is that the poor tend to actually pay more for things. This is known in America as "The Poverty Trap" because the fact that things cost more make it very difficult to escape poverty. The root of the poverty spiral is the modern dependence on credit. When someone does not have money, and they miss payments on credit cards or other loans, this lowers their credit rating. Then if they get a mortgage, it will be with a considerably higher interest rate. If a person cannot afford a car, they may have to shop at local convenience stores where prices are higher, instead of at supermarkets. If a person does not have a bank account, they have to cash their paychecks at local stores which charge a fee. When someone buys something such as a television on an installment plan, they end up paying considerably more than they would if they could have afforded to buy it outright. They are thus trapped in poverty because so many things cost more.

A healthy economy is one that is, plainly and simply, free of these destructive spirals.

The Wave Model Of Economics

Today, I would like to describe my long-term view of economics as a wave.

In idealized form economics, and thus politics, would reach an equilibrium of wages and prices, of supply and demand, and would then remain fairly static, with the exception of shortages caused by changes in population or factors of nature. Let's picture this equilibrium as the smooth surface of a pond.

Economics is, of course, somewhat more complicated than this. the reason for this is that events tend to come along, which we can consider here as stones thrown into our nice, smooth pond. Let's have a look at the major world events that have created waves in the economics and politics of America over the past century.

Republican (conservative) and Democrat (liberal) administrations do alternate on the political scene and this is one form of wave, from left to right. The waves in this model here also swing from left to right, but are of much longer duration. These longer "waves" are the result of "stones" thrown into our "pond" in the form of world events. The usual alternation of parties in power would occur even in a smooth pond, but the waves described here would not.

The First World War was a large stone thrown into America's economic pond. There was a tremendous increase in the production of all types of war equipment. America was involved in the war for only about a year, because it did not enter until 1917. When the war was over, the economy moved to the right as the productive capacity for the war shifted to consumer goods. Confidence from the victory contributed to the atmosphere of the "Roaring Twenties". There were two consecutive Republican presidential administrations as the rich got really rich.

The trouble was that goods were being turned out of factories, using the newly-perfected assembly line manufacturing process, at a rapid rate, but the workers were not being paid enough to be able to afford enough of the goods so that they would all be sold. Manufactured goods began piling up in warehouses, and factories began cutting back on the frenzied production. This meant that workers had even less money to spend on the goods being produced, and it spiraled into the devastating economic crash of 1929.

This led to a dramatic shift leftward in the 1930s, as the government began all manner of projects to get the country working again. This leftward shift was, in my model here, the return wave of the rightward shift following World War One.

The Second World War was another massive stone thrown into America's economic pond. But it's effect was very different from that of World War One. World War Two also involved mass production of war vehicles, aircraft and other equipment. The difference in the economic effect of the two wars is that The Second World War involved far more of a shift in the workforce.

Many more Americans served in World War Two than in World War One, and for a much longer duration. Women, such as the iconic "Rosie the Riveter", made up much of the workforce during the war. When the soldiers returned after the war, it prompted a leftward shift in the economic wave from the extensive government housing projects to the G.I. Bill for veterans to advance their educations.

This leftward wave following World War Two was of much longer duration (or wavelength) than that after World War One. The way I see it, this leftward postwar economic wave continued until the election of Ronald Reagan in 1980. The peak of this leftward wave was the presidency of John F. Kennedy, it's demise was the rampant inflation of the late 1970s.

The rightward return wave, which began with the election of Ronald Reagan, continued until the election of Barack Obama in 2008. The demise of this wave was, of course, the economic crash of 2008. Apparently, the waves from World War Two crashing into the pond have not finished playing out yet.

You may wonder why World War One resulted in a rightward economic wave, while World War Two was the opposite. The reason is that the First World War had more of an effect on the production capacity than it did in the workforce shift, as workers left to serve in the military.

The Second World War resulted in a workforce shift that had much more long-term effect than the production shift. Many more men served in the U.S. military, and for a much longer time, in the Second World War than in the first. Also, the majority of the factories producing war equipment and vehicles for the Second World War were already in existence before the war, producing consumer goods. This had not been as much the case with the First World War.

This left-right wave actually has nothing to do with the usual alternating left-right of the presidential administrations. There will be both Republican and Democrat administrations on both sides of the wave. In the wave pair after the Second World War, there was the Democrat Clinton Administration on the rightward wave and, there were the Republican Eisenhower, Nixon and, Ford Administrations on the leftward wave. But these Republicans were quite moderate in comparison with those on the rightward waves.

As you can see, the amazing thing about these waves is that when there is a wave in one direction for a period of time, the return wave in the opposite direction always lasts for an approximately equal period of time. The economic wave set up by World War One lasted about twelve years in each direction. Not counting the years of World War Two itself, the wave set up by it lasted about thirty-two years in each direction, first to the left and then to the right.

The economic crash of 1987 might have been a good reason to begin a new wave, but it wasn't. Had it been, it would have broken the apparent rule that the return wave must be approximately equal in duration to the initial wave. The Korean and Vietnam Wars apparently did not have enough impact on production and the workforce to change the basic wave pattern.

Economic waves can operate in parallel also. Communism began as a leftward wave in response to the rightward wave of capitalism, and it's abusive nature. The two parallel waves affected each other, just as two water or electromagnetic waves of the same wavelength will, both began with extremes of left and right, but shifted toward the center over time.

Inflation And Debt

I find that the debt crisis in Europe illustrates how debt and inflation are actually different manifestations of the same thing, that being the inability of a country to live and function within it's means. The two are very interchangeable.

My interpretation of this crisis is that certain countries have been in the habit of paying down some of their debt by simply printing more money, and accepting the resulting moderate level of inflation. When European countries gave up their former currencies and joined the euro, they gained many advantages. However, one price that they paid was giving up the ability to print their own money. The euro is printed by the European Central Bank.

Since joining the euro, those countries cannot print more money to pay down national debt. They have essentially traded inflation for debt. That is why the debt of some European countrties today seems to be such an issue. It's not that it wasn't there, at least to some degree, previously. It's just that it can no longer be exchanged at will for inflation.

Nowadays, with the vast majority of financial transactions being done electronically, we could eliminate inflation fairly easily. All that we would have to do is to time-stamp every input of money, such as an investment or bank deposit, and maintain a central index of inflation. This would not cover paper currency, but most people and businesses only hold paper money for a very limited time. I know that paper money leaves my wallet really quickly.

It is often said that "The past is another country". When one goes from one country to another, currency can be readily exchanged. Time-stamping transactions would operate on the same principle, by determining the "exchange rate" between a time in the past, and the present. It would work so that one might be told "You deposited a thousand dollars (euros, pounds, rupees, etc.) on December 13, 2009, so, according to the inflation index, that would give you $1,087.23 today". This would effectively eliminate inflation.

The reason that we do not do this is obvious. Eliminating inflation would make debt even more glaring. Governments would lose the ability to accept a little bit of inflation to pay off some debt. Inflation actually is a form of tax because it spreads the burden to everyone of the government printing more money for it's coffers. Instead of the government raising your taxes, they just take some of the value of your money by decreasing it's purchasing power.

A low percentage of annual inflation is usually acceptable, as long as it does not increase to destructive levels. Debt and inflation are opposite sides of the same coin, and until a country can live and operate within it's means the best approach to the resulting bill is a sensible mix of debt and inflation. At least there is not any interest on inflation, like there is on debt. Inflation also decreases the amount of real money that the government owes on it's remaining debt.

The countries using the euro had to give up this option when they joined the common currency. The reason that we do not eliminate inflation by time-stamping is that it is actually useful, at least to a certain extent, as an alternative to debt.

The Trouble With Ratings Agencies

In considering what can be done to improve the global economy, today I would like to add my opinion to those who think that these ratings agencies, the best-known three are Moody's, Standard & Poor and, Fitch, have entirely too much power.

A rating agency can downgrade a country or a corporation, and risk sending the economy into a tailspin. I referred to this in the posting on the economics blog, "Economic Collapse" that I wrote in the autumn of 2008. These agencies operate on the same principle as the four that rate the credit scores of individuals in the U.S.

The trouble with these ratings is that they tend to be self-fulfilling. The effect is similar to that of continuously announcing that there is going to be a recession. Such warnings cause more people to be cautious about spending and hiring, and this in itself is what brings about the recession.

When a country is struggling economically, and gets it's credit rating lowered by one of these agencies, investors will tend to abandon the country's bonds. It's borrowing costs will rise, causing it to struggle even more and thus perpetuating the cycle of self-fulfillment.

The same effect of self-fulfillment can be seen with individual credit scores in the U.S. When someone's score is raised, it enables him to get loans easier and with lower interest rates and improves employment prospects, all of which tend to make the score rise even more. But when someone's score is lowered, it makes loans more expensive and lowers employment prospects, which invite further lowering of the score.

Due to this self-fulfillment effect, these ratings agencies cause the economy to be more volatile than it would otherwise be. An announcement of either a rise or a drop in the score invites further movement in that direction. Those with upgrades look better than they really are, and those with downgrades look worse than they really are. The effect can be compared with that of global warming, the wet will be wetter still and the dry will be dryer still. The ratings of companies like AIG were a significant factor in the economic meltdown of 2008.

Like any human organization, we can be sure that these ratings agencies are less than perfect. All of this is a part of our dependence on credit. Investors seem to treat reports from these agencies like the word of God. The resulting upward and downward spirals of self-fulfillment are among the spirals that I described in the posting "The Healthy Economy" on this blog.

By the way, I am not writing this posting just because Standard & Poor recently downgraded the United States for the first time in it's history. I wrote out this posting before that happened.

The Very Slow Economic Recovery

The Recession, which began with the economic crash of 2008, is officially over. But the recovery is going extremely slowly, unemployment in the U.S. is close to ten percent and Europe is mired in it's debt crisis.

Part of the trouble is certainly factors that I have explained in previous postings. We need a continuous flow of new ideas for products in order for new industries to replace those which have permanently shed jobs. If we do not produce enough of these new ideas, we will fall behind on what I have termed "The Idea Curve" and will remain afflicted by unemployment.

As for the wealth structure, as I explained in detail on the economics blog, if too much wealth is taken by those few that are the richest then there will not be enough money left in circulation to buy all of the goods and services that are being produced. Since it does not make sense to produce goods and services that are not going to sell, industries will cut back on production and let workers go, which means that the average worker has even less money to spend, thus furthering the recessionary spiral.

Over the past few decades, the number of millionaires has dramatically increased and many that were once mere millionaires are now billionaires. The trouble is that this shift of wealth has left everything else nearly broke.

But yet, there is a still deeper reason behind the slowness of the recovery that goes beyond the left or right of the economic system itself.

On this economics blog there is a posting titled "The Three Fundamental Costs". We know that, in a free market economy, prices are determined by the Law of Supply and Demand. But if we take this further, we find that there are three fundamental costs which determine what the price of anything will be.

The Three Fundamental Costs are: The cost of land, the cost of communications and, the cost of transportation.

The most fundamental of the three is the cost of land. The buildings where goods are produced and sold and where economic transactions take place must be built upon land. The result is that the cost of land finds it's way into everything that is sold.

The simplest illustration of this is the way everything costs more in cities. There is more demand for land, this raises it's cost according to supply and demand, and the cost finds it's way into everything else.

The cost of land is the most fundamental of the Three Fundamental Costs. But it is also the one over which we have the least control. There is only a fixed amount of land. We could spread cities out so that there would effectively be more land, but that would only raise the cost of transportation.

The factor that we should consider, with regard to the slowness of the economic recovery is actually an index of the other two fundamental costs: The cost of communication multiplied by the cost of transportation. This is really what governs, at a fundamental level, the state of the economy. That is why I have called this "The Three Fundamental Costs". This does not mean that we need to do a literal calculation of this index.

There is a posting on the progress blog, http://www.markmeekprogress.blogspot.com/ , about our technical progress in recent times in communications, as opposed to the parallel progress in transportation. The posting is titled "Parallel Revolutions" and it describes how fantastic progress has been made in the field of communications while transportation has lagged far behind. While that posting is about technology, it is relevant to our discussion of economics here because technical progress lowers the costs.

Back in the Nineteenth Century, transportation and communications revolved around the railroad and the telegraph and the costs of both were high. The great post-war economic boom in the western countries rode especially on the low cost of transportation that resulted from the mass-production of vehicles and trucks, combined with cheap fuel and the construction of an extensive system of highways and main roads. Television drastically lowered the cost of one-way communication for advertising, but point-to-point communication by telephone to set up business deals was still expensive.

Those were the days when, in terms of economics, much more progress was made in the field of transportation than in that of communications. Fuel was cheap, but phone calls were expensive and there was no internet. The global business network that we have today was built upon these low transportation costs.

But progress in communications caught up to that in transportation. The general increase in productivity since the end of the recession in the early 1980s rode upon the continuous drop in the cost of communications, just as the earlier postwar boom did on the drop in the cost of transportation. The development of the internet, high-capacity satellite communications and fibre optics, and the mass-marketing of personal computers and mobile phones has made global communication and information searching so cheap that it is nearly free.

These two, of the Three Fundamental Costs, are what really drives the economy at it's most fundamental level. Notice that during the time of the nasty recession in the early 1980s, the cost of communication was still high and the price of fuel had really began to climb, compared to what it had been in the 1970s.

There was dramatic technical progress in communications, which brought a corresponding lowering of that fundamental cost, during the 1980s and into the following decade. The 1990s were a boom time because the internet, mobile phones and fibre optic technology had opened up a world of communication possibilities, while the cost dropped like a stone, and while the cost of fuel was still relatively low.

But the new millennium brought troubles. The cost of communication still continued to drop, but the cost of fuel went into an upward climb. Not long after just about everyone got online, the price of fuel underwent a really big increase.

Fuel had been increasing in price for quite some time, but this had earlier been outpaced by the drop in communication costs. This increase in fuel prices in the new millennium lowered the economic index that I explained, based on the Three Fundamental Costs. With all other factors being equal, economic activity is in inverse proportion to the cost of communication multiplied by the cost of transportation.

Put simply, there is nothing that we can possibly do to stimulate an economic recovery like lowering the cost of transportation. As I pointed out in "Parallel Revolutions", we need to repeat the progress that was made in communications in recent decades, in the field of transportation. This must necessarily mean doing away with fossil fuels, and running vehicles on other sources such as the energy from sunlight.

When the price of fuel increases, it makes everything else more expensive. Not only do you have to pay more to get to work and to the store, but when you get to the store things are more expensive because it cost more to transport them to the store. This takes a massive cut out of the consumer spending that is necessary to drive the economy, and this is what is hindering an economic recovery.

Just stop and think what it would be like if half of the money that is spent on fuel, across the economy, was spent on other goods. We would have a boom town and would be far wealthier than we are now.