Capital and Capitalism

Posted by PITHOCRATES - May 7th, 2012

Economics 101

Entrepreneurs have an Insatiable Desire to Think and Create

It takes money to make money.  For it is money that buys the means of production.  The land, manufacturing plants, small shops, office space, machines, equipment and infrastructure that make things.  The trucks, barges, container ships, locomotives and rolling stock that transport raw material, work-in-progress and finished goods.  These physical assets are capital.  From assembly lines to inventory control systems to accounting software.  Things that let businesses conduct business.  And make profits.

This is the key to capitalism.  Profits.  It’s what allows businesses to make the things we need and enjoy.  Profits are what make an entrepreneur take a risk.  To spend their life savings.  To mortgage their home.  To borrow from a bank.  They do these things because they believe they will be able to earn enough profits to replenish their life savings.  To make their mortgage payments.  To repay their loans.  AND to earn a living in the process.  It is a risky endeavor.  And far more risky than working for someone and earning a steady paycheck.  But if entrepreneurs didn’t take these risks we wouldn’t have things like the iPhone or the automobile or the airplane.  All of which were brought to us because one person had an idea.  And then invested in the capital to bring that idea to market.

Some business ideas succeed.  Many more fail.  But people keep trying.  Because of that insatiable desire to think and create.  And the ability to earn profits to pay for their ideas.  To build on their ideas.  To expand their ideas.  From the first thoughts of it they kicked around in their head.  To the multinational corporations their ideas grew into.  All made possible by the profits they earned.  The more they earned the more they could do.  As they reinvested those earnings into their businesses.  To buy more capital.  That allowed them to build more things.  And use even more capital to bring these things to market.  Creating jobs all along the way.  Jobs that only came into being because of those profits that started as a single thought in someone’s head.

If you can’t Service your Debt your Creditors can and will Force you into Bankruptcy

This is where corporations come from.  From a single thought.  Profitable business operations grow that thought into the corporations they become.  For corporations are not the evil spawn of the damned.  Corporations come from people having a great idea.  Like Starbucks.  And Ben and Jerry’s.  Who are now everywhere so we can enjoy their products wherever we are.  All made possible by the profits of capitalism.

Who’s up for a little accounting?  You are?  Well, then, you came to the right place.  For we’re going to learn a little accounting.  Right here.  Right now.  Corporations determine their profits by closing their books at the end of an accounting period.  A series of accounting steps culminate in the trial balance.  Where the sum of all debits equal the sum of all credits.  Or eventually do after various adjusting entries.  Once they do the books are balanced.  And business at last can see if they were profitable.  By producing an income statement.  Which lists revenue at the top.  Then sums all costs (materials, production wages, payroll taxes & health insurance for that labor, etc.) that produced that revenue.  Subtracting these costs from revenue gives you gross profit.  Then comes overhead costs.  Fixed costs.  Like rent and utilities.  And overhead labor (corporate officers, management, accounting, human resources, etc.).  They sum these and subtract them from gross profit.  Which brings us to earnings before interest and taxes (EBIT).  A very important profitability number.  For if there is any money left by the time you reach EBIT your business operations were profitable.  Your business was able to pay all the due bills to produce your revenue.  Which leaves just two numbers.  Interest they owe on their loans.  And income taxes.

EBIT is a very important number.  For if it’s not large enough to service your debt everything above EBIT is for naught.  Because if you can’t service your debt your creditors can and will force you into bankruptcy.  Never a good thing.  And what follows is usually the opposite of growing your business.  Shrinking your business.  By seriously cutting costs (i.e., massive layoffs).  And eliminating unprofitable lines of revenue.  Downsizing and reorganizing as necessary so your cost structure can produce a profit at the given market price for your goods and/or services.  A price determined by your competition in the market.  If you cannot downsize and reorganize sufficiently to become profitable then you go out of business.  Or you sell the business to someone who can make a profit.  Because unless you can turn a profit your business will consume money.  And that money has to come from somewhere.  Typically it is the business owner until they run out of life savings and home to mortgage.  Because a bank can’t give you money to lose in your business.  For their depositors put their money into the bank to grow their savings.  Not to shrink them.  So a bank has to be profitable to please their depositors.  And if the bank is using their money to make bad loans they will remove their money.  As will other depositors.  Perhaps creating a run on the bank.  And causing the bank to fail.  So while operating at a loss will save employees jobs in the short term it will cause far greater harm in the long term.  Which isn’t good for anyone.

Capitalism works because with Risk there’s Reward

As you can see getting those accounting reports to fairly state the profitability of a business is crucial.  For it’s the only way a business knows if it can pay its bills.  And the way they pay their bills complicate matters.  Revenue and costs come in at different times.  To bring order to this chaos businesses use accrual accounting.  Which includes two very important rules.  To record accurately when revenue is revenue (for example, a down payment is not revenue.  It’s a liability a business owes the customer until the sale transaction is complete).  And to match costs to revenue.  Meaning that every cost a business incurred producing a sale is matched to that sale.  Even long-term fixed assets like buildings and machinery.  Which they depreciate over the life of the asset.  Charging a depreciation expense each accounting period until the asset is fully depreciated.

Because of these accounting reports that fairly state business operations a business knows if they are profitable.  That they can pay all of their bills.  Their suppliers AND their employees.  Their health insurance AND their payroll taxes.  The interest on their debt AND their income taxes.  They can pay all of these when they come due.  And not run out of money when other bills come due.  Which is why they can have confidence when they read their income statement.  Knowing that they paid all their costs due in that accounting period.  Including the interest on their debt.  And their income taxes.  Which takes them to the bottom line.  Net profit.  And if it’s positive they have money to reinvest into their business.  To expand operations.  To increase sales revenue.  Create more jobs.  And they can grow.  But not too much that they lose control.  So they can always pay their bills.  So they can keep doing what they love.  Thinking.  And bringing new ideas to market.

This is capitalism.  Where people take risks.  In hopes of making profits.  They invest in capital to make those profits.  And then use those profits to invest in capital.  It works because there is a direct relationship between risk and profits.  It’s why people take risks.  Create jobs.  And provide the things we need and enjoy.  Because with risk there’s reward.  And accounting reports that fairly state business operations give a business’ management the tools to be profitable.  By matching costs to revenue.  Telling them when they are not using their capital efficiently.  Helping them to stay profitable.  (Unlike anything the government runs.  Because there is no matching of costs to revenue.  Taxes come into the treasury and the treasury pays for a multitude of things.  With no way to know if they are using those taxes efficiently).  And this is capitalism.  Risk and reward.  And accountability.  For when you’re risking your money you become very accountable.  Which is why capitalism works .  And government-run entities don’t.

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Market Economy, Command Economy and Market Failures

Posted by PITHOCRATES - April 30th, 2012

Economics 101

Money replaced the Barter System making it Easier to Trade Freely and Voluntarily

We did our first economic exchanges in a market economy.  Agricultural advances gave us our first food surpluses.  These food surpluses gave people free time.  To do other things besides growing food.  Like developing an alphabet and writing.  Mathematics.  A code of laws.  And we made material goods.  Like pottery.  Farming tools.  Processing olive oil for lamps.  People who were good at making one thing made a lot of that one thing and traded with other people.  Who were good at making one thing themselves.  These people met.  And traded.  Freely and voluntarily.

Free trade.  A key element of the market economy.  Where people freely met and traded the things they made.  With other people who are freely trading the things they made.  Free trade came before money.  We bartered our first trades.  Trading goods for goods.  We then created money to make our trades easier.  Reducing the search time to find people to trade with.

Money is something that can store value.  Which allowed people to trade their goods for money.  Then they took that money and traded it with someone else.  To get something they wanted.  Money allowed people to spend less time finding people to trade with.  Because you didn’t have to find that one person that had what you wanted AND was willing to trade it for what you made.  Money allowed us to advance beyond the barter system.  Which proved more and more inefficient as we produced more and more goods.

Because of Market Failures the Government taxes to Provide Public Goods and Eliminate the Free-Rider Problem

As we produced more and more goods our standard of living rose.  We had more things in our lives that made that life easier.  More comfortable.  And more enjoyable.  Civilizations with a bustling market economy were great places to live.  Because there were a lot of nice things to make life better.  Which other people saw.  From beyond the civilization.  And they wanted what they saw.  And they took it.  By force.  Raiding parties would enter a developed civilization and rape, murder and plunder.  So to enjoy the amenities of an advanced civilization required the ability to protect your civilization.  Which led to one of the first market failures.  The failure of the market to provide city defenses through the free and voluntary trading of people engaged in economic activity.

We call it a market failure because building city defenses and creating an army are things the market economy can’t provide.  One person can’t make a fort or an army.  And trade it with someone else.  It’s too big.  It takes a lot of people and a lot of effort to make these things.  But it doesn’t take everyone.  If everyone else is contributing one person could skip contributing.  That person would still be able to enjoy the benefits of that fort and army.  Living in safety.  And enjoy living in safety for free.  Something we call the free-rider problem.  The fort and army are examples of public goods.  Things the free market can’t provide.  Or that the free market fails to provide.  Not that the market is broken or operating poorly.  It’s because people rarely act freely and voluntarily to benefit other people.  Because any time and money spent doing this is time and money taken away from their own families.  Which would bring hardship to them.  So the government provides these things that are necessary AND cause personal hardship to individuals to provide.  The government forces everyone to contribute.  Which minimizes the hardship each individual must bear.

Some in power like to take this further.  And call things that people can provide for themselves that benefit only themselves public goods, too.  Such as health care.  Higher education.  Housing.  Food.  Everything the people can buy for themselves by working to earn the money to buy these things.  And when they do they alone enjoy the benefits of these goods.  These goods they incurred hardships to obtain.  By working to earn a paycheck.  Or sacrificing other things to have these things instead.  It’s their call.  Their choice.  A choice they enter freely and voluntarily.  Therefore these things are not public goods.  But that doesn’t stop some people from acting like they are public goods.  Usually to help them win an election to office.  Or to overthrow the government.

A Command Economy reduced Economic Activity and Introduced a Police State

Civilizations with a bustling market economy were great places to live.  If you had talent and ability.  If you did then you could work hard and trade your talent and ability for a paycheck.  That you could use to trade for other things in that bustling economy.  Those with great talent and ability would be able to trade these for great paychecks.  Those with less talent and ability would be able to trade these for lesser paychecks.  Which, of course, caused income inequality.  Which is a handy thing to exploit if you want to seize power.  So you can enjoy the best things the civilization has to offer.  When your talent and ability only can trade for one of those lesser paychecks.

History is full of people trying to seize power.  So this is nothing new.  What was new was the way these people seized power.  By using the teachings of Karl Marx and Friedrich Engels.  As they wrote in the Communist Manifesto.  Who attacked market economies.  And capitalism.  Saying that the new middle class, the bourgeois, maximized profits by exploiting the working class.  The proletariat.  Which they said was unfair.  And that the only way to make things fair was to destroy the very concept of private property.  Because only the bourgeois accumulated private property.  The proletariat had none.  And only got poorer and poorer while the bourgeois got richer and richer.  Under their system, then, nothing belonged to the person.  Everything belonged to the state.  If you created something with your talent and ability it belonged to the state.  And then the state determined how to distribute the fruit of your labors.  Basically according to the rule ‘from those according to ability to those according to need’.  Those with the greatest need got the most stuff.  And those with the most ability worked the hardest.  Well, you can just guess how that worked out.  Everyone tried to show as little ability as possible and the greatest need as possible.

Because people weren’t the masters of their talent and ability anymore they couldn’t trade freely and voluntarily.  Which meant there was no longer a market economy.  Instead there was a command economy.  Where the government made all the decisions.  What to make.  How to use resources.  Where people lived.  Where they worked.  And what prices they paid for the things in the state-run stores.  Which had shelves full of things no one wanted to buy.  And empty shelves where the staples went (soap, toilet paper, etc.).  Because the government decided what to bring to the state-run stores.  And in what quantity.  Not people trading freely and voluntarily.  Which reduced economic activity.  Reduced living standards.  And introduced a police state.  Because anyone who had a chance to escape to a market economy did.  Which is why the East Germans built a wall in Berlin.  To keep their people from escaping their command economy.  And going to the market economy across the street.

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The Invisible Hand

Posted by PITHOCRATES - April 16th, 2012

Economics 101

A Command Economy Reduces the Overall Economic Output because those Managing the Economy don’t Understand It

Command economy?  Or free market capitalism?  Which works better?  Well, let’s find out with a little experiment.  Let’s go back in time.  Say ancient Mesopotamia.  Just after they developed mass farming.  And produced some of the first food surpluses.  Allowing the rise of a middle class of artisans.  Now let’s look at what could have been the first two of these artisans.  A potter.  And a winemaker.  Who probably weren’t the first two artisans.  But will suffice for our little experiment.

The winemaker needs some pottery vessels to store and sell his wine in.  And the potter enjoys drinking wine.  They each have something the other wants.  And because we’re so far back in time there is no money yet.  We’re still only bartering at this time.  Trading the goods we make with each other.  But in our experiment the high priest of the civilization is also the economic planner.  This priest communicates to the civilization’s gods.  And guides the civilization in pleasing their gods.  Which he is very good at.  For he knows all of the old teachings and rituals.  But he doesn’t know a thing about pottery or winemaking.  But he looks at an empty pottery vessel and a pottery vessel full of wine and sees that the vessel volume equals the volume of wine.  And deems the price of one pottery vessel is the amount of wine one pottery vessel holds.

Well, the potter is quite happy with this price.  Because he is skilled.  And can dig up some clay.  Throw it on the potter’s wheel and knock out vessel after vessel.  Glaze them and fire them in the kiln.  Even working by himself he can achieve some economies of scale.  By repeating this process every day.  Something the winemaker isn’t quite able to.  For he makes wine by the batch.  Because each step in the process takes a lot of time.  Maintaining his grape vines.  Then picking the grapes.  Carrying them back to his winery.  Putting them into his winepress.  Squeezing the juice out of the grapes.  Putting the grape juice in large vats to ferment.  Monitoring the process.  When he determines the process is complete he fills the small pottery vessels with wine.  When it was finally ready for ‘sale’ and consumption.  Considering all the work it took him to make one vessel of wine the winemaker was not at all happy with the price the high priest set.  And instead builds his own potter’s wheel and kiln to make his own vessels.  Greatly increasing his workload.  And reducing his winemaking output.  While the potter loses a potentially large customer.  Thus reducing the amount pottery he makes.  Reducing overall economic output in the command economy.

The Invisible Hand makes sure we use our Limited Resources Efficiently to Make the Things People want Most

In this command economy the civilization suffered a deadweight loss.  Economic resources went unused.  They could have created more economic benefits with the available resources.  They could have made more pottery.  And made more wine.  Perhaps even creating some jobs to help with the economic output of efficiently using the available resources.  But they didn’t.  Because of the fixed prices economic resources went unused.  Thus creating a market equilibrium lower than where it could be.  Hence the deadweight loss.  Now let’s look at the same example with only one difference.  The high priest does NOT set prices.

In a barter economy people agree to trade the goods they make.  And now the potter and the winemaker are free to determine what they think is a fair trade.  That is, they set the price of pottery in wine.  And the price they agree on is one they find mutually acceptable.  Where the potter agrees to trade an amount of his pottery for an amount of wine.  And the winemaker agrees to trade an amount of his wine for an amount of pottery.  Everyone wins.  For the potter gets an amount of wine he values more than the pottery he traded for the wine.  The winemaker gets an amount of pottery he values more than the wine he traded for the pottery.  And the civilization wins because at this mutually agreed upon price both the potter and the winemaker increase their production.  Providing the civilization with more of their goods.  The potter and the winemaker may even hire people to help them produce more goods to meet this higher demand.  Thus increasing the level of happiness in the civilization.  By increasing the amount of economic activity.  Moving the market equilibrium to a higher level of economic output.  And thus reducing the deadweight loss.  By using the available resources in the most efficient manner.  As determined by these mutually agreed upon prices.

This is the Invisible Hand in action.  An economic concept put forth by Scottish economist Adam Smith (1723-1790) in his The Wealth of Nations (1776).  In a competitive market place where traders set the price for their economic trade (not a command economy) two things happen.  First, resources flow to where we demand them most.  That is, to the buyers willing to pay the highest price.  Second, because of the competitive market place only those companies that sell at the low prices the market demands stay in business.  Which means that they have to use those resources as efficiently as possible.  Especially when they’re paying the highest prices for them.  And all of this happens because of the Invisible Hand. 

History has Proven that no Government Bureaucrat can do a Better Job than the Invisible Hand

Those who favor a command economy (or more government intervention into market forces) say the economy is too complex for us to leave it to its own devices.  That without a smart government bureaucrat managing this complex thing we cannot reach a market equilibrium that maximizes economic output.  Whereas Adam Smith says it is because the economy is so complex that no one is smart enough to manage it.  Just as a high priest doesn’t understand pottery or winemaking a smart government bureaucrat cannot hope to understand all the intricacies of a complex economy.  Nor can they ever hope to understand what millions upon millions of consumers want to buy most.  But the beautiful thing is we don’t have to.

The multitudes make individual decisions just like our potter and winemaker.  Where everyone is looking to maximize their own value.  And when they agree on a mutual acceptable price all parties in the trade win.  While making sure our resources flow to where they are demanded most.  And that we use these valuable and limited resources most efficiently.  Thus maximizing overall happiness in our country.  Reducing deadweight losses to a minimum.  And obtaining a market equilibrium that maximizes economic activity.  All of which happens with no one in charge.  As if an Invisible Hand guides us in the market place to make all the right decisions to maximize this economic output.  And our happiness.

So which is better?  Command economy or free market capitalism.  Well, if you’re being honest you have to choose Adam Smith’s Invisible Hand and free market capitalism.  For history has proven that no government bureaucrat can do a better job than the Invisible Hand.  Not the Soviets.  Not the Chinese Communist (under Chairman Mao).  Not the Cubans.  Not the North Koreans.  Even the Americans failed when their government actively intervened in the private economy.  Something that President Jimmy ‘one-term’ Carter knows only too well.  So based on our hypothetical Mesopotamian example, and history in general, free market capitalism is, and always has been, and always will be, better than a command economy.

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Trade, Steam Power, Reciprocating Steam Engine, Railroading, Janney Coupler and Westinghouse Air Brake

Posted by PITHOCRATES - January 25th, 2012

Technology 101

Early Cities emerged on Rivers and Coastal Water Regions because that’s where the Trade Was

The key to wealth and a higher standard of living has been and remains trade.  The division of labor has created a complex and rich economy.  So that today we can have many things in our lives.  Things that we don’t understand how they work.  And could never make ourselves.  But because of a job skill we can trade our talent for a paycheck.  And then trade that money for all those wonderful things in our economy.

Getting to market to trade for those things, though, hasn’t always been easy.  Traders helped here.  By first using animals to carry large amounts of goods.  Such as on the Silk Road from China.  And as the Romans moved on their extensive road network.  But you could carry more goods by water.  Rivers and coastal waterways providing routes for heavy transport carriers.  Using oar and sail power.  With advancements in navigation larger ships traveled the oceans.  Packing large holds full of goods.  Making these shippers very wealthy.  Because they could transport much more than any land-based transportation system.  Not to mention the fact that they could ‘bridge’ the oceans to the New World.

This is why early cities emerged on rivers and coastal water regions.  Because that’s where the trade was.  The Italian city-states and their ports dominated Mediterranean trade until the maritime superpowers of Portugal, Spain, The Netherlands, Great Britain and France put them out of business.  Their competition for trade and colonies brought European technology to the New World.  Including a new technology that allowed civilization to move inland.  The steam engine.

Railroading transformed the Industrial Economy

Boiling water creates steam.  When this steam is contained it can do work.  Because water boiling into steam expands.  Producing pressure.  Which can push a piston.  When steam condenses back into water it contracts.  Producing a vacuum.   Which can pull a piston.  As the first useable steam engine did.  The Newcomen engine.  First used in 1712.  Which filled a cylinder with steam.  Then injected cold water in the cylinder to condense the steam back into water.  Creating a vacuum that pulled a piston down.  Miners used this engine to pump water out of their mines.  But it wasn’t very efficient.  Because the cooled cylinder that had just condensed the steam after the power stroke cooled the steam entering the cylinder for the next power stroke.

James Watt improved on this design in 1775.  By condensing the steam back into water in a condenser.  Not in the steam cylinder.  Greatly improving the efficiency of the engine.  And he made other improvements.  Including a design where a piston could move in both directions.  Under pressure.  Leading to a reciprocating engine.  And one that could be attached to a wheel.  Launching the Industrial Revolution.  By being able to put a factory pretty much anywhere.  Retiring the waterwheel and the windmill from the industrial economy.

The Industrial Revolution exploded economic activity.  Making goods at such a rate that the cost per unit plummeted.  Requiring new means of transportation to feed these industries.  And to ship the massive amount of goods they produced to market.  At first the U.S. built some canals to interconnect rivers.  But the steam engine allowed a new type of transportation.  Railroading.  Which transformed the industrial economy.  Where we shipped more and more goods by rail.  On longer and longer trains.  Which made railroading a more and more dangerous occupation.  Especially for those who coupled those trains together.  And for those who stopped them.  Two of the most dangerous jobs in the railroad industry.  And two jobs that fell to the same person.  The brakeman.

The Janney Coupler and the Westinghouse Air Brake made Railroading Safer and more Profitable

The earliest trains had an engine and a car or two.  So there wasn’t much coupling or decoupling.  And speed and weight were such that the engineer could stop the train from the engine.  But that all changed as we coupled more cars together.  In the U.S., we first connected cars together with the link-and-pin coupler.  Where something like an eyebolt slipped into a hollow tube with a hole in it.  As the engineer backed the train up a man stood between the cars being coupled and dropped a pin in the hole in the hollow tube through the eyebolt.  Dangerous work.  As cars smashed into each other a lot of brakemen still had body parts in between.  Losing fingers.  Hands.  Some even lost their life.

Perhaps even more dangerous was stopping a train.  As trains grew longer the locomotive couldn’t stop the train alone.  Brakemen had to apply the brakes evenly on every car in the train.  By moving from car to car.  On the top of a moving train.  Jumping the gap between cars.  With nothing to hold on to but the wheel they turned to apply the brakes.  A lot of men fell to their deaths.  And if one did you couldn’t grieve long.  For someone else had to stop that train.  Before it became a runaway and derailed.  Potentially killing everyone on that train.

As engines became more powerful trains grew even longer.  Resulting in more injuries and deaths.  Two inventions changed that.  The Janney coupler invented in 1873.  And the Westinghouse Air Brake invented in 1872.  Both made mandatory in 1893 by the Railroad Safety Appliance Act.  The Janney coupler is what you see on U.S. trains today.  It’s an automatic coupler that doesn’t require anyone to stand in between two cars they’re coupling together.  You just backed one car into another.  Upon impact, the couplers latch together.  They are released by a lifting a handle accessible from the side of the train.

The Westinghouse Air Brake consisted of an air line running the length of the train.  Metal tubes under cars.  And those thick hoses between cars.  The train line.  A steam-powered air compressor kept this line under pressure.  Which, in turn, maintained pressure in air tanks on each car.  To apply the brakes from the locomotive cab the engineer released pressure from this line.  The lower pressure in the train line opened a valve in the rail car air tanks, allowing air to fill a brake piston cylinder.  The piston moved linkages that engaged the brake shoes on the wheels.  With braking done by lowering air pressure it’s a failsafe system.  For example, if a coupler fails and some cars separate this will break the train line.  The train line will lose all pressure.  And the brakes will automatically engage, powered by the air tanks on each car.

Railroads without Anything to Transport Produce no Revenue

Because of the reciprocating steam engine, the Janney coupler and the Westinghouse Air Brake trains were able to get longer and faster.  Carrying great loads great distances in a shorter time.  This was the era of railroading where fortunes were made.  However, those fortunes came at a staggering cost.  For laying track cost a fortune.  Surveying, land, right-of-ways, grading, road ballast, ties, rail, bridges and tunnels weren’t cheap.  They required immense financing.  But if the line turned out to be profitable with a lot of shippers on that line to keep those rails polished, the investment paid off.  And fortunes were made.  But if the shippers didn’t appear and those rails got rusty because little revenue traveled them, fortunes were lost.  With losses so great they caused banks to fail.

The Panic of 1893 was caused in part by such speculation in railroads.  They borrowed great funds to build railroad lines that could never pay for themselves.  Without the revenue there was no way to repay these loans.  And fortunes were lost.  The fallout reverberated through the U.S. banking system.  Throwing the nation into the worst depression until the Great Depression.  Thanks to great technology.  That some thought was an automatic ticket to great wealth.  Only to learn later that even great technology cannot change the laws of economics.  Specifically, railroads without anything to transport produce no revenue.

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Money

Posted by PITHOCRATES - November 7th, 2011

Economics 101

The High Search Costs of the Barter System Hindered Trade

Agriculture advances gave us food surpluses.  Food surpluses gave us a division of labor.  The division of labor gave us trade.  And trade gave us an advanced civilization.  By allowing more specialists to live together in crowded urban settings.  Creating a rich surplus of goods for trade.  That people traded.  With other people.  Near.  And far.

As trade grew civilizations got better.  The division of labor grew larger.  And more complex.  Producing more things.  Soon there was a rich variety of goods to trade with for other goods.  From civilizations in distant lands.  Which made life more interesting.  And enjoyable.  During that brief time when you weren’t working.  Or trading.  Which was taking more and more time.  To find someone to trade with.  That had something you wanted.  And who wanted something you had.

This is the barter system.  Trading goods for goods.  Producers took their goods to other producers.  And asked, “What will you take in trade for that?”  Often the response was, “Nothing that you have.”  To which the trader replied, “Very well.  I shall keep looking.”  And sometimes would spend days, weeks and even months looking.  And that was time spent not making anything new.  This was the high search cost of the barter system.  And it hindered trade.  We needed something better.

Money made Trade more Efficient and Unleashed the Human Capital of the Middle Class

For civilization to advance further we had to make trade more efficient.  We had to reduce these search costs.  What we needed was a temporary storage of value.  Something we could trade our valuable goods for.  And then trade the value of our goods, held temporarily in this temporary storage of value, for something else of value later.  And we call this temporary storage of value money.

Money greatly simplified things.  Allowed a more complex economy.  A greater division of labor.  And it allowed wages.  Allowing more people to work on more narrow specialties.  These producers could then take their wages to market.  And buy what they needed.  Instead of spending days, weeks or even months traveling to find people to barter with.

Money made trade more efficient.  It allowed cities to grow in size.  And become even more advanced.  It unleashed the human capital of the middle class.  For they could spend more time creating and building new and better things to trade.  And this economic activity allowed more people to live together peacefully.  As producers produced.  And traded with other producers.  All made easier by money.  A temporary storage of value.

Money doesn’t Create or Produce, it just Temporarily Stores the Value of what we Create and Produce

Please note what came first here.  First there was trade.  Then there was money to make that trade more efficient.

At the heart of all economic activity is our human capital.  What we use to create and produce.  Money doesn’t create or produce.  It just stores the value of what we create and produce.  Which is why Keynesian economic stimulus doesn’t work.  Making money to give to people to spend simply does not create new economic activity.

Our skills create economic activity.  That ability to create things other people value.  And wish to trade for.  Because we are traders.  Not spenders.  We trade things of value.  And to trade things of value someone has to create them first.  If you just take things of value without offering something of value in trade it is not trade.  It’s plunder.  And little different from the uncivilized barbarians on the frontier of the civilized world.

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Trade

Posted by PITHOCRATES - October 31st, 2011

Economics 101

People Traded the Things they Made to have Things they couldn’t Make

Agricultural advances gave us food surpluses.  Food surpluses gave us the division of labor.  And spare time.  For the first time everyone didn’t have to hunt or gather food.  They could do other things.  Think.  Experiment.  Innovate.  Create.  And they did.  Becoming specialists.  A middle class.  Artisans.  People who became very good at doing one thing.  So they kept doing that one thing.  Finding ways to improve that one thing.  And created surpluses of their own.  Potters made excess pottery.  Shoemakers made excess shoes.  Tanners made excess leather goods.  Metalworkers made excess metal goods.

Cities grew in the center of the sprawling farmland.  And it was in the cities where these artisans lived.  Where they honed their specialties.  And met.  With other specialists.  And with farmers.  To trade.  The potter would trade pottery for shoes.  The farmer would trade food for shoes and metal goods.  The tanner would trade leather goods for pottery, shoes and food.  And so on.  People traded the things they made.  To have things they couldn’t make.  Everyone was able to have more things.  Thanks to this trade.

This unleashed the vast human capital of the people.  Their cities.  And their civilization.  Cities on the coast fished.  Cities closer to the forest harvested wood.  Cities closer to the hills mined silver, gold and copper.  And coal.  And the cities traded their surpluses with other cities.  Metal workers and potters traded their goods for fuel for their forges and kilns.  Miners traded their ore and coal for grain and fish.  Either directly.  Or indirectly.  When other people traded their large surpluses with other people in other cities.  With the miners getting a portion of these large-scale trades for all their efforts to make those trades possible.

As Civilizations became more Complex they became more Dependent on Trade

All of this trading made cities grow.  And as a result the civilization they belonged to grew.  And became more advanced.  People ventured further.  Looking for other resources.  And met people from other civilizations.  Who had raw materials that were different and interesting.  As well as finished goods that were different and interesting.  And these civilizations traded with each other.

Civilizations established trade routes with each other.  Which connected civilizations with others in the unknown world.  Beyond the civilizations they knew.  Markets appeared on these trade routes.  Bringing the exotic from the furthest corners of the world to everyone.  As well as new ideas.  And innovation.  The civilized world grew more advanced.  More interdependent.  More peaceful.  And better.  There was more food.  More technology.  More goods and services.  And more leisure.  Giving rise to the arts.  And entertainment.

But it was not all good.  As cities grew they grew attractive to the uncivilized barbarians beyond the frontier.  Roving bands of hunters and gatherers.  Who were more partial to plunder than trade.  So a portion of their surpluses had to be set aside for city defenses.  The building of city walls.  Implements of wars.  And standing armies.  To defend their cities.  Their civilizations.  And their trade routes.  For as civilizations became more complex they became more dependent on trade.

Trade Improved the Quality of Life which is the Hallmark of an Advanced Civilization

Trade unleashed our human capital.  Because it drove innovation.  There was a big world out there.  Creating a lot of fascinating stuff.  And the only way to get it was to trade your fascinating stuff for it.  And when we did everyone won.  Life got better.  We learned new and interesting things.  That we used as building blocks for further innovation.  And further advancement.  Which led to a better quality of life.  The hallmark of an advanced civilization.

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