## Saturday, November 25, 2017

### Behold: Internal Factors

Suppose we have a tiny economy in equilibrium. An economy similar to an early medieval, non-monetary economy. Ten people each producing 12 per year of whatever it is they produce. Each guy takes one of what he produces as his profit, barters nine, and pays the remaining 2 to the lord of the manor as taxes.

This little society can run at that speed forever. You can assume barter conditions that make it fail, of course. But for purposes of equilibrium, we assume barter conditions that make it not fail: Everybody trades one-for-one with nine of his neighbors.

The equilibrium could be upset by an external factor: One guy dies, for example, or a mutant fungus kills his crop. Or somebody revises these sentences.

But there are no internal factors that might arise to destroy the equilibrium. By this I mean the numbers work. Each year 10 people produce 120 things and consume 100 of them, and the lord of the manor consumes the other 20. There are no excesses, no shortages, nothing to upset the apple cart.

We could plug money into this model and it will still work just as well: Each year 10 people produce \$120 of things, 10 people consume \$100 worth, and one person consumes \$20 worth. There are no excesses and no shortages.

But in this case, to make it work, we also have to assume that nobody does any saving. Maybe the lord of the manor is getting fat because he consumes twice as much as everybody else. So he goes on a diet. He decides to save \$10 each year, and only consume \$10 worth like everybody else.

So now the tiny economy could still produce just as much as ever, but it doesn't, because the people can't afford to buy it all because they don't have the money. Ten dollars disappeared. Ten dollars disappears every year. This can't go on forever. Our little economy will soon run out of money.

You could fix the problem by setting up a system of lending and borrowing. Now it appears that this economy can again go on forever.

But things are going on here that we cannot see. To see them we need more columns in the table. We need a category for accumulated savings and another for accumulated debt. And if our system of lending and borrowing requires that interest be paid, we need a column for that, too.

Everything is fine now, as long as everybody can borrow all they need. They still need to borrow \$10 every year to bring consumption up to \$120, plus now they need to borrow a little more to cover the interest owed.

But that means people have to borrow more each year than the year before. Before long they will have to borrow more each year than they produce!

And the amount they have to borrow still keeps getting bigger every year. At some point the lord of the manor, the guy with all the savings, decides it's just not worth the risk any more. He says "That's it! No more borrowing! Everybody pay up!" But how can you pay up when you owe \$234 and have no savings?

So life as we know it comes to an end.

It is not the "real" economy that's the problem here. Everyone can still produce just as much as before. But they don't, because the equilibrium has collapsed.

The problem is in the money. The money problem crashed the "real" economy.

An internal factor crashed the economy.

jim said...

"plus now they need to borrow a little more to cover the interest owed."

That's a questionable assumption. What it implies is that the saver will save forever and never spend from savings (not even the interest).
What happens if you construct a model where there exists a rational saver in the economy who is not willing to save for no purpose at all and decides to save for a purpose and when the time comes spends the savings on that purpose?

The problem with your model is you created a saver that is totally bonkers. If he had a lick of sense he would figure out that he has no savings at all. All he has is IOUs from destitute people who can never pay and the process is making them even more destitute.
If he were smart he would quickly realize he should be doing the exact opposite. That is, spending more than income and issuing IOUs to cover the extra spending. Try that model and see where it goes.

If you construct a model where borrowing has no purpose ( other than staying alive a bit longer) and saving has no rational purpose at all then you are going to have a pretty ugly economy.

The Arthurian said...

Jim: "That's a questionable assumption. What it implies is that the saver will save forever and never spend from savings (not even the interest)."

What it implies is that the saver will not spend 100% of what he has saved. As long as savings is growing, I think my assumption is valid.

"The problem with your model is you created a saver that is totally bonkers. If he had a lick of sense he would figure out that he has no savings at all. All he has is IOUs from destitute people who can never pay and the process is making them even more destitute."

I know! Where did I ever get such a crazy idea?!

jim said...

"What it implies is that the saver will not spend 100% of what he has saved."

It sounds like he won't ever get to spend any of his
savings.

When the saver decided to save that was the point where the equilibrium was broken.

What the saver's saving meant to the workers is that they each year could produce 10% less or consume 10% more of their own production. Or they could even leverage the new surplus capacity they now enjoy to expand their capital and increase future productive capacity. At any rate they have no reason to complain about the silly irrational game that their lord has decided to play.

The important point that the MMT people will point out is that to have a money economy, taxes must be paid in money. If the workers paid taxes in goods it would have no impact on them if tax collector consumed them or saved them. If you had created a model where the tax collector was a dis-saver instead of a saver the outcome over time would be much less likely to be feudalism

The Arthurian said...

After a long delay...
Jim, you said:
"That's a questionable assumption. What it implies is that the saver will save forever and never spend from savings (not even the interest)."

I replied: "What it implies is that the saver will not spend 100% of what he has saved."

Better, here is Keynes:
"... we have no such easy escape from the sufferings of unemployment. We have to accept them as an inevitable result of applying to the conduct of the State the maxims which are best calculated to “enrich” an individual by enabling him to pile up claims to enjoyment which he does not intend to exercise at any definite time."