From Commodity Money to Representative Money to Fiat Money

Posted by PITHOCRATES - April 8th, 2014

History 101

(Originally published November 8th, 2011)

The Drawbacks to Using Pigs as Money Include they’re not Portable, Divisible, Durable or Uniform

They say we use every part of the pig but the oink.  So pigs are pretty valuable animals.  And we have used them as money.  Because they’re valuable.  People were willing to accept a pig in trade for something of value of theirs.  Because they knew they could always trade that pig to someone else later.  Because we use every part of the pig but the oink.  Which makes them pretty valuable.

Of course, there are drawbacks to using pigs as money.  For one they’re not that portable.  They’re not that easy to take to the market.  And they’re big.  Hold a lot of value.  So what do you do when something is worth more than one pig but not quite worth two?  Well, pigs aren’t readily divisible.  Unless you slaughter them.  But then you’d have to hurry up and trade the parts before they spoil because they’re not going to stay fresh long.  For pig parts aren’t very durable.

Suppose you have two pigs.  And someone has something you want and they will trade two pigs for it.  But there’s only one problem.  One pig is big and healthy.  The other is old and sickly.  And half the weight of the healthy one.  This trader was willing to take two pigs in trade.  But clearly the two pigs you have are unequal in value.  They’re not uniform.  And not quite what this trader had in mind when he said he’d take two pigs in trade.

Our Paper Currency Evolved from the Certificates we Carried for our Gold and Silver we Kept Locked Up

Rats are more uniform.  They’re more portable.  And they’re smaller.  It would be easier to price things in units of rats rather than pigs.  They would solve all the problems of using pigs as money.  Except one.  Rats are germ-infested parasites that no one wants.  And they breed like rabbits.  You never have only one rat.  Man has spent most of history trying to get rid of these vile disease carriers.  So no one would trade anything of value for rats.  Because these little plague generators were overrunning cities everywhere.  So rats were many things.  But one thing they weren’t was scarce.

Eventually we settled on a commodity that addresses all the shortcomings of pigs and rats.  As well as other commodities.  Gold and silver.  These precious metals were portable.  Durable.  They didn’t spoil and held their value for a long time.  You could make coins in different denominations.  So they were easily divisible.  Unlike a pig.  They were uniform.  Unlike pigs.  Finally, you had to dig gold and silver out of the ground.  After digging a lot of holes trying to find gold and silver deposits.  Which made it costly to bring new gold and silver to market.  Keeping gold and silver scarce.  And valuable.  Unlike rats.

But gold and silver were heavy metals.  Carrying large amounts was exhausting.  And dangerous.  A chest of gold and silver was tempting to thieves.  As you couldn’t hide it easily.  Soon we left our gold and silver locked up somewhere.  And carried certificates instead that were exchangeable for that gold and silver.  And these became our paper currency.

Governments Everywhere left the Gold Standard in the 20th Century so they could Print Fiat Money

The use of certificates like this is typically what people mean by gold standard.  Money in circulation represents the value of the underlying gold or silver.  And can be exchanged for that gold or silver.  Which meant that governments couldn’t just print money.  Like they do today.  Because the value was in the gold and silver.  Not the paper that represented the gold and silver.  And the only way to create money was to dig it out of the ground, process it and bring it to market.  Which is a lot harder to do than printing paper money.  So governments everywhere left the gold standard in the 20th century in favor of fiat money.  So they could print money.  Create it out of nothing.  And spend it.  With no restraints of responsible governing whatsoever.

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Quantitative Easing, Inflation and Gold

Posted by PITHOCRATES - September 23rd, 2013

Economics 101

The FOMC makes Money out of Nothing to Buy the Bonds for their Quantitative Easing

The Federal Open Market Committee (FOMC) decided to keep their quantitative easing.  Their monthly $85 billion purchase of Treasury Securities and mortgage bonds.  To stimulate the economy.  Which hasn’t stimulated the economy.  But it has greatly expanded the money supply.

When people buy Treasury Securities and mortgage bonds they have to first work and save up the money.  Then when they buy these investments they no longer have that money.  It’s how we buy things.  We exchange money for things.  So we can have the money or the things.  But never both.

Unless you’re the federal government.  That has the power to print money.  When they make these monthly $85 million purchases of Treasury Securities and mortgage bonds they pay for them with an electronic transfer of money.  They add money to the account of the holders of the Treasury Securities and mortgage bonds.  And that’s it.  They subtract no money from their ledgers.  Because they ‘printed’ that money.  Just made it out of nothing.  Literally.

The Danger of a highly Inflated and Devalued Currency is that it loses its Purchasing Power and People lose Faith in It

The Secret Service protects our presidents.  Ironically, the president that created the Secret Service was assassinated.  Abraham Lincoln.  Who created it not to protect presidents.  But to combat a great threat to the country.  Counterfeiting.  The scourge of paper money.

During the American Revolutionary War the Continental Congress had no hard money (i.e., precious metals) to pay the Continental Army.  So they resorted to printing paper money.  Igniting massive inflation.  The more money they printed the greater the inflation.  And the greater they devalued the dollar.  Requiring more and more of them to buy what they once did.  Until no one would accept them in payment anymore.  Forcing the army to take what they needed from the people.  Leaving behind IOUs for the Congress to honor.  Once they figured out how to do that.

This is the danger of a highly inflated and devalued currency.  It loses its purchasing power.  Until it gets so weak that the people lose faith in it.  And refuse to accept it anymore.  Returning to the barter system instead.  Trading things that hold their value for other valuable things.  But the barter system has high search costs.  It takes a lot of time for people to find each other that can trade with each other.  Greatly reducing economic activity.  And crashing a nation’s economy.  Which is what Abraham Lincoln wanted to prevent.  And why a lot of America’s enemies have tried to flood the American economy with counterfeit bills.

The Hard-Money Prices remained Relatively Constant during the Inflationary Periods of the Revolutionary War

With the FOMC’s decision to continue their quantitative easing the stock market soared.  As investors were instead expecting a ‘tapering’.  A reduction in their purchases of Treasury Securities and mortgage bonds.  And if the government stopped creating this money out of nothing to buy bonds from these investors these investors could not continue to buy and sell in the market like they were doing.  Pocketing handsome profits in the process.  Which is why they were so happy to hear the FOMC would continue their currency devaluation to continue buying like they had been.

But this continued currency devaluation has a down side.  For it can’t go on forever.  There will come a point when it ignites inflation.  Causing prices to soar.  Requiring more and more dollars to buy what they once bought before.  So with this possibility on the horizon and with continued currency devaluation some people were taking steps to protect their assets.  Especially their cash.  For there is nothing worse than having a lot of cash when it’s losing its purchasing power at an alarming rate.  So they convert that cash into something that holds it value better.  Such as precious metals.  Which is why when the dollar tanked (after the FOMC decision) the price of gold surged.

So what’s the difference between gold and paper money?  Well, the government can’t print gold.  They can’t create gold out of nothing and add it to someone’s account.  So they can’t devalue gold.  And because of this gold will hold its value during inflationary periods.  Which was why during the Revolutionary War people sold things with two prices.  One was in paper Continental Dollars.  With these prices increasing sometimes daily.  And one in hard money (i.e., precious metals).  The hard money prices remained relatively constant.  Even during the inflationary periods of the Revolutionary War.

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Rand Paul says Milton Friedman would oppose the Fed’s Bond Buying Program

Posted by PITHOCRATES - August 17th, 2013

Week in Review

What’s the difference between hard money (gold, silver, etc.) and paper money?  You can’t print hard money.  Which is why big-spending governments hate hard money.  And love paper money.  They use lofty economic explanations like having the money supply grow at a rate to support an expanding economy.  But the real reason they love paper money is because there is no limit on what they can spend.

This is why some people would prefer bringing back the gold standard.  To make the government as responsible as the rest of us.  Governments and their liberal friends hate this kind of talk.  And try to dismiss it with all-knowing condescension.  Because they sound so learned in their defense of their monetary policies despite a long record of failure they get to keep trying the same failed policies of the past.

Now it’s Rand Paul talking about the gold standard.  Invoking the name of Milton Friedman.  A monetarist.  And receiving the expected criticism (see Rand Paul is dead wrong about Milton Friedman by James Pethokoukis posted 8/13/2013 on the guardian).

Friedman understood the power of monetary policy, for both good and ill. He would almost certainly have been aghast that the Fed blew it again in 2008 by its tight money policies that possibly turned a modest downturn into the Great Recession. And he almost certainly would have been appalled at Republicans pushing for tight money – or, heaven help us, a return to the gold standard – with the economy barely growing and inflation low. It is certainly inconvenient for Paul that Friedman – a libertarian, Nobel-laureate economist – would have little use for the senator’s supposedly Hayekian take on the Fed or monetary policy.

Although the Bernanke Fed has imperfectly executed its QE programs, they are a big reason why the US is growing and adding jobs – despite President’s Obama’s regulatory onslaught and tax hikes – and the EU (and the inflation hawk ECB) is back in recession. Paul is wrong on Friedman and wrong on the Fed. It’s not even close.

One of Friedman’s criticisms of the gold standard is that to maintain the international price of gold—and price stability—governments would have to give up control of their domestic policies.  As a gold standard would prevent them from expanding the money supply at will.  So they couldn’t print money and devalue their currency to increase government spending.  To give themselves an unfair trade advantage.  And to monetize their debt from past irresponsible government spending.  But governments being governments they will do these things even with a gold standard.  As Richard Nixon and the US government did in the 1970s.  Rapidly devaluing the dollar.  Causing a great outflow of gold from the US as our trading partners preferred to hold onto gold instead of devalued US dollars.

The idea of monetarism was to have something similar like a gold standard while having the ability to expand the money supply to keep up with the growth in GDP.  And this would work if responsible people were in charge.  Who would resist the urge to print money.  Like Ronald Reagan.  Under the advice from none other than Milton Friedman.  Who served on the President Reagan’s Economic Policy Advisory Board.  Reagan shared Friedman’s economic views.  Believed in a limited government that left the free market alone.  So Reagan cut taxes, reduced government spending (other than defense) and deregulated an overregulated free market wherever he could.  All things Friedman endorsed.

It is unlikely that Friedman would endorse any quantitative easing.  Because a lack of credit is not causing our economic woes.  It’s a complicated tax code.  High tax rates.  And way too much governmental regulation and interference into the free market.  Especially Obamacare.  That has frozen all new hiring.  And pushed full-time workers into part-time positions.  Or out of a job entirely.  More money in the economy is not going to fix this anti-business climate of the Obama administration.  In fact, the only people making any money now are rich people.  Who are using all that new money to make more money in the stock market.  And when the government shuts off the quantitative easing tap those rich people are going to bail out of the stock market.  To lock in their profits.  Causing the stock market to crash.  And putting an end to the phony illusion of an economic recovery.  And the worst economic recovery since that following the Great Depression will get worse.

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Quantitative Easing

Posted by PITHOCRATES - June 24th, 2013

Economics 101

The Gold Standard prevented Nations from Devaluing their Currency to Keep Trade Fair

You may have heard of the great gamble the Chairman of the Federal Reserve, Ben Bernanke, has been making.  Quantitative easing (QE).  The current program being QE3.  The third round since the subprime mortgage crisis.  It’s stimulus.  Of the Keynesian variety.  And in QE3 the Federal Reserve has been ‘printing’ $85 billion each month and using it to buy financial assets on the open market.  Greatly increasing the money supply.  But why?  And how exactly is this supposed to stimulate the economy?  To understand this we need to understand monetary policy.

Keynesians hate the gold standard.  They do not like any restrictions on the government’s central bank’s ability to print money.  Which the gold standard did.  The gold standard pegged the U.S. dollar to gold.  Other central banks could exchange their dollars for gold at the exchange rate of $40/ounce.  This made international trade fair by keeping countries from devaluing their currency to gain a trade advantage.  A devalued U.S. dollar gives the purchaser a lot more weaker dollars when they exchange their stronger currency for them.  Allowing them to buy more U.S. goods than they can when they exchange their currency with a nation that has a stronger currency.  So a nation with a strong export economy would like to weaken their currency to entice the buyers of exports to their export market.  Giving them a trade advantage over countries that have stronger currencies.

The gold standard prevented nations from devaluing their currency and kept trade fair.  In the 20th century the U.S. was the world’s reserve currency.  And it was pegged to gold.  Making the U.S. dollar as good as gold.  But due to excessive government spending through the Sixties and into the Seventies the American central bank, the Federal Reserve, began to print money to pay for their ever growing spending obligations.  Thus devaluing their currency.  Giving them a trade advantage.  But because of that convertibility of dollars into gold nations began to do just that.  Exchange their U.S. dollars for gold.  Because the dollar was no longer as good as gold.  So nations opted to hold gold instead.  Instead of the U.S. dollar as their reserve currency.  Causing a great outflow of gold from the U.S. central bank.

Going off of the Gold Standard made the Seventies the Golden Age of Keynesian Economics

This gave President Richard Nixon quite the contrary.  For no nation wants to lose all of their gold reserves.  So what to do?  Make the dollar stronger?  By not only stopping the printing of new money but pulling existing money out of circulation.  Raising interest rates.  And forcing the government to make REAL spending cuts.  Not cuts in future increases in spending.  But REAL cuts in current spending.  Something anathema to Big Government.  So President Nixon chose another option.  He slammed the gold window shut.  Decoupling the dollar from gold.  No longer exchanging gold for dollars.  Known forever after as the Nixon Shock.  Making a Keynesian dream come true.  Finally giving the central bank the ability to print money at will.

The Keynesians said they could make recessions a thing of the past with their ability to control the size of the money supply.  Because everything comes down to consumer spending.  When the consumers spend the economy does well.  When they don’t spend the economy goes into recession.  So when the consumers don’t spend the government will print money (and borrow money) to spend to replace that lost consumer spending.  And increase the amount of money in circulation to make more available to borrow.  Which will lower interest rates.  Encouraging people to borrow money to buy big ticket items.  Like cars.  And houses.  Thus stimulating the economy out of recession.

The Seventies was the golden age of Keynesian economics.  Freed from the responsible restraints of the gold standard the Keynesians could prove all their theories by creating robust economic activity with their control over the money supply.  But it didn’t work.  Their expansionary policies unleashed near hyperinflation.  Destroying consumers’ purchasing power.  As the greatly devalued dollar raised prices everywhere.  As it took more of them to buy the things they once did before that massive inflation.

The only People Borrowing that QE Money are Very Rich People making Wall Street Investments

The Seventies proved that Keynesian stimulus did not work.  But central bankers throughout the world still embrace it.  For it allows them to spend money they don’t have.  And governments, especially governments with large welfare states, love to spend money.  So they keep playing their monetary policy games.  And when recessions come they expand the money supply.  Making it easy to borrow.  Thus lowering interest rates.  To stimulate those big ticket purchases.  But following the subprime
mortgage crisis those near-zero interest rates did not spur the economic activity the Keynesians thought it would.  People weren’t borrowing that money to buy new houses.  Because of the collapse of the housing market leaving more houses on the market than people wanted to buy.  So there was no need to build new houses.  And, therefore, no need to borrow money.

So this is the problem Ben Bernanke faced.  His expansionary monetary policy (increasing the money supply to lower interest rates) was not stimulating any economic activity.  And with interest rates virtually at 0% there was little liquidity Bernanke could add to the economy.  Resulting in a Keynesian liquidity trap.  Interest rates so close to zero that they could not lower them any more to create economic activity.  So they had to find another way.  Some other way to stimulate economic activity.  And that something else was quantitative easing.  The buying of financial assets in the market place by the Federal Reserve.  Pumping enormous amounts of money into the economy.  In the hopes someone would use that money to buy something.  To create that ever elusive economic activity that their previous monetary efforts failed to produce.

But just like their previous monetary efforts failed so has QE failed.  For the only people borrowing that money were very rich people making Wall Street investments.  Making rich people richer.  While doing nothing (so far) for the working class.  Which is why when Bernanke recently said they may start throttling back on that easy money (i.e., tapering) the stock market fell.  As rich people anticipated a coming rise in interest rates.  A rise in business costs.  A fall in business profits.  And a fall in stock prices.  So they were getting out with their profits while the getting was good.  But it gets worse.

The economy is not improving because of a host of other bad policy decisions.  Higher taxes, more regulations on business, Obamacare, etc.  And a massive devaluation of the dollar (by ‘printing’ all of that new money) just hasn’t overcome the current anti-business climate.  But the potential inflation it may unleash worries some.  A lot.  For having a far greater amount of dollars chasing the same amount of goods can unleash the kind of inflation that we had in the Seventies.  Or worse.  And the way they got rid of the Seventies’ near hyperinflation was with a long, painful recession in the Eighties.  This time, though, things can be worse.  For we still haven’t really pulled out of the Great Recession.  So we’ll be pretty much going from one recession into an even worse recession.  Giving the expression ‘the worst recession since the Great Depression’ new meaning.

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Currencies, Exchange Rates and the Gold Standard

Posted by PITHOCRATES - June 17th, 2013

Economics 101

Money is a Temporary Storage of Value that has no Intrinsic Value

Giant container ships ply the world’s oceans bringing us a lot of neat stuff.  Big televisions.  Smartphones.  Laptop computers.  Tablet computers.  The hardware for our cable and satellite TVs.  Toasters.  Toaster ovens.  Mixers and blenders.  And everything else we have in our homes and in our lives.  Things that make our lives better.  And make it more enjoyable.  These things have value.  We give them value.  Some have more value to one than another.  But these are things that have value to us.  And because they have value to us they have value to the people that made them.  Who used their human capital to create things that other people wanted.  And would trade for them.

When we first started trading we bartered with others.  Trading things for other things.  But as the economy grew more complex it took a lot of time to find someone who had what you wanted AND you had what they wanted.  So we developed money.  A temporary storage of value.  So we could trade the valuable things we created for money.  That money held the value of what we created temporarily while we looked for something that we wanted.  Then we exchanged the money we got earlier for something someone had.  It was just like trading our thing for someone else’s thing.  Only instead of spending weeks, months even years meeting hundreds of thousands of people trying to find that perfect match we only needed to meet two people.  One that exchanges money for the thing we have that they want.  And another who has what we want that they will exchange for our money.  Then that person would do the same with the money they got from us.  As did everyone else who brought things to market.  And those who came to market with money to buy what others brought.

Money is a temporary storage of value.  Money itself doesn’t have any intrinsic value.  Consider that container ship full of those wonderful items.  Now, which would you rather have as permanent fixtures in your house?  Those wonderful things?  Or boxes of money that just sit in your house?  You’d want the wonderful things.  And if you had a box of money you would exchange it (i.e., go out shopping) for those wonderful things.  Because boxes of money aren’t any fun.  It’s what you can exchange that money for that can be a lot of fun.

Devaluing your Currency boosts Exports by making those Goods less Expensive to the Outside World

So there is a lot of value on one of those container ships.  Let’s take all of that value out of the ship and place it on a balancing scale.  Figuratively, of course.  Now the owner of that stuff wants to trade it for other stuff.  But how much value does this stuff really have?  Well, let’s assume the owner is willing to exchange it all for one metric ton of gold.  Because gold is pretty valuable, too.  People will trade other things for gold.  So if we put 1 metric ton of gold on the other side of the balancing scale (figuratively, of course) the scale will balance.  Because to the owner all of that stuff and one metric ton has the same value.  Of course moving a metric ton of gold is not easy.  And it’s very risky.  So, instead of gold what else can we put on that scale?  Well, we can move dollars electronically via computer networks.  That would be a lot easier than moving gold.  So let’s put dollars on the other side of that scale.  Figuratively, of course.  How many will we need?  Well, today gold is worth approximately $1,380/troy ounce.  So after some dimensional analysis we can convert that metric ton into 32,150 troy ounces.  And at $1,380/troy ounce that metric ton of gold comes to approximately $44.4 million.  So that container ship full of wonderful stuff will balance on a scale with $44.4 million on the other side.  Or 1 metric ton of gold.  In the eyes of the owner they all have the same value.

Moving money electronically is the easiest and quickest manner of exchanging money for ships full of goods.  These ships go to many countries.  And not all of them use American dollars.  But we can calculate what amounts of foreign currency will balance the value of that ship.  Or one metric ton of gold.  By using foreign exchange rates.  Which tell us the value of one currency in another currency.  Something that comes in pretty handy.  For when, say, an American manufacturer sells their goods they want American dollars.  Not British pounds.  Danish kroner.  Or Russian rubles.  For American manufacturers are in the United States of America.  They buy their materials in American dollars.  They pay their employees in American dollars.  Who pay their bills in American dollars.  Go shopping with American dollars.  Etc.  For everyday American transactions the British pound, for example, would be un-useable.  What these American manufacturers want, then, are American dollars.  So before a foreigner can buy these American exports they must first exchange their foreign currencies for American dollars.  We can get an idea of this by considering that container ship full of valuable stuff.  By showing what it would cost other nations.  The following table shows a sampling of foreign exchange rates and the exchanged foreign currency for that $44.4 million.

foreign currencies and exchange rates

If we take the US dollars and the Exchanged Currency for each row and place them on either side of a balancing scale the scale will balance.  Figuratively, of course.  Meaning these currencies have the same value.  And we can exchange either side of that scale for that container ship full of valuable stuff.  Or for that metric ton of gold.  Why are there such large differences in some of these exchange rates?  Primarily because of a nation’s monetary policy.  Many nations manipulate their currency for various reasons.  Some nations give their people a lot of government benefits they pay for by printing money.  Which devalues their currency.  Some nations purposely devalue their currency to boost their export sector.  As the more currency you get in exchange for your currency the more of these exports you can buy.  Most of China’s great economic growth came from their export sector.  Which they helped along by devaluing their currency.  This boosted exports by making those goods less expensive to the outside world.  But the weakened yuan made domestic goods more expensive.  Because it took more of them to buy the same things they once did.  Raising the cost of living for the ordinary Chinese.

The Gold Standard made Free Trade Fair Trade

Some economists, Keynesians, approve of printing a lot of money to lower interest rates.  And for the government to spend.  They think this will increase economic activity.  Well, keeping interest rates artificially low will encourage more people to buy homes.  But because they are devaluing the currency to keep those interest rates artificially low housing prices rise.  Because when you devalue your currency you cause price inflation.  But it’s just not house prices that rise.  Prices throughout the economy rise.  The greater the inflation rate (i.e., the rate at which you increase the money supply) the higher prices rise.  And the less your money will buy.  While the currencies at the top of this table will have exchange rates that don’t vary much those at the bottom of the table may.  Especially countries that like to print money.  Like Argentina.  Where the inflation is so bad at times that Argentineans try to exchange their currency for foreign currencies that hold their value longer.  Or try to spend their Argentine pesos as quickly as possible.  Buying things that will hold their value longer than the Argentine peso.

Because printing fiat money is easy a lot of nations print it.  A lot of it.  People living in these countries are stuck with a rapidly depreciating currency.  But international traders aren’t.  If a country prints so much money that their exchange rate changes every few minutes international traders aren’t going to want their currency.  Because a country can’t do much with a foreign currency other than buy exports with it from that country.  A sum of highly depreciated foreign currency won’t buy as much this hour as it did last hour.  Which forces an international trader to quickly spend this money before it loses too much of its value.  (Some nations will basically barter.  They will exchange their exports for another country’s exports based on the current exchange rate.  So that they don’t hold onto the devalued foreign currency at all.)  But if the currency is just too volatile they may demand another currency instead.  Like the British pound, the euro or the American dollar.  Because these stronger currencies will hold their value longer.  So they’ll buy this hour what they bought last hour.  Or yesterday.  Or last week.  There is less risk holding on to these stronger currencies because Britain, the European Central Bank and the United States aren’t printing as much of their money as these nations with highly devalued currencies are printing of theirs.

This is the advantage of gold.  Countries can’t print gold.  It takes an enormous expense to bring new gold to the world’s gold supply.  It’s not easy.  So the value of the gold is very stable.  While some nations may devalue their currencies they can’t devalue gold.  A nation printing too much money may suffer from hyperinflation.  Reducing their exchange rate close to zero.  And when you divide by a number approaching zero the resulting amount of currency required for the exchange approaches infinity.  Weimar Germany suffered hyperinflation.  It was so bad that it took so much money to buy firewood that it was easier and less expensive to burn the currency instead.  This is the danger of a government having the ability to print money at will.  But if that same country can come up with a metric ton of gold that person with the container ship full of wonderful stuff would gladly trade it for that gold.  Even though that person will not trade it for that country’s currency.  This was the basis of the gold standard in international trade.  When nations backed their currencies with gold.  And kept them exchangeable for gold.  Forcing nations to maintain stable currencies.  By maintaining an official exchange rate between their currency and gold.  If that nation devalued its currency the market exchange rate will start to move away from the official exchange rate.  For example, say the official rate was $40/troy ounce.  But because they printed so much of their currency they devalued it to where it took $80 to buy a troy ounce on the open market.  So a nation could take $80 dollars of that devalued currency and exchange it for 2 troy ounces of gold from that nation.  The official exchange rate forcing the nation to give away 2 troy ounces of gold for $80 when the real market exchange rate would only have given them 1 troy ounce.  So devaluing your currency would cause gold to flow out of your country.  And the only way to stop it would be to decrease the size of your money supply.  Undoing the previous inflation.  To bring the market exchange rate back to the official exchange rate.  Which is why the gold standard worked so well for international trade.  Nations could not manipulate their currency to get a trade advantage over another nation.  Making free trade fair trade.  Something few say today.  Thanks to currency manipulators like China.

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If the U.S. was on a Gold Standard there would NOT have been a Financial Crisis in 2007

Posted by PITHOCRATES - June 9th, 2013

Week in Review

Counterfeiting money is against the law.  We all know this.  But do we understand why?  Today’s money is just fiat money.  The Federal Reserve prints it and simply says it is money.  So why is it okay for them to print money but not for anyone else?  Because the amount of money in circulation matters.

The goods and services that make up our economy grow at a given rate.  You hear numbers like GDP of 2%, 3% or more.  In China they had GDP numbers in excess of 8%.  The goods and services in our economy are what have value.  Not the money.  It just temporarily holds the value of these goods and services as they change hands in the economy.  So the amount of money in circulation should be close to the value of goods and services in the economy.  Think of a balancing scale.  Where on the one side you have the value of all goods and services in the economy.  And on the other you have the amount of money in circulation.  If you increase the amount of money on the one side it doesn’t increase the amount of goods and services on the other side.  But it still must balance.  So as we increase the amount of money in circulation the value of each dollar must fall to keep the scale in balance.

Now when we put our money into the bank for our retirement we don’t want the value of those individual dollars grow less over time.  Because that would reduce the purchasing power of our money in the bank.  Making for an uncomfortable retirement.  This is why we want a stable dollar.  One that won’t depreciate away the value of our retirement savings, our investments or the homes we live in.  We’d prefer these to increase in value.  But we can stomach if they just hold their value.  For awhile, perhaps.  But we cannot tolerate it when they lose their value.  Because when they do years of our hard work just goes ‘poof’ and disappears.  Leaving us to work longer and harder to make up for these losses.  Perhaps delaying our retirements.  Perhaps having to work until the day we die.  So we want a stable currency.  Like the gold standard gave us (see Advance Look: What The New Gold Standard Will Look Like by Steve Forbes posted 5/8/2013 on Forbes).

The financial crisis that began in 2007 would never have happened had the Federal Reserve kept the value of the dollar stable. A housing bubble of the proportions that unfolded–not to mention bubbles in commodities and farmland–would not have been possible with a stable dollar. The Fed has also created a unique bubble this time: bonds. It hasn’t popped yet (nor has the farmland bubble), but it will.

The American dollar was linked to gold from the time of George Washington until the early 1970s. If the world’s people are to realize their full economic potential, relinking the dollar to gold is essential. Without it we will experience more debilitating financial disasters and economic stagnation.

What should a new gold standard look like? Representative Ted Poe (R-Tex.) has introduced an original and practical version. Unlike in days of old we don’t need piles of the yellow metal for a new standard to operate. Under Poe’s plan–an approach I have long favored–the dollar would be fixed to gold at a specific price. For argument’s sake let’s say the peg is $1,300. If the price of gold were to go above that, the Federal Reserve would sell bonds from its portfolio, thereby removing dollars from the economy to maintain the $1,300 level. Conversely, if the gold price were to drop below $1,300, the Fed would “print” new money by buying bonds, thereby injecting cash into the banking system.

Yes, the subprime mortgage crisis and the Great Recession would not have happened if the Federal Reserve kept the dollar stable.  Instead, they kept printing and putting more money into circulation.  Why?  To keep interest rates low.  To encourage more and more people to buy a house.  Even people who weren’t planning to buy a house.  Even people who couldn’t afford to buy a house.  Until, that is, subprime lending took off.  Because of those low interest rates.  With all of these people added to the housing market who otherwise would not have been there (because of the Federal Reserve’s monetary policies of printing money to keep interest rates artificially low) the demand for new houses exploded.  As people tried to buy these before others could house prices soared.  Creating a great housing bubble.  Houses worth far greater than they should have been.  And when the bubble burst those housing prices fell back to earth.  Often well below the value of the outstanding balance of the mortgage on the house.  Leaving people underwater in their mortgages.  And when the Great Recession took hold a lot of two-income families went to one-income.  And had a mortgage payment far greater than a single earner could afford to pay.

So that’s how that mess came about.  Because the Federal Reserve devalued the dollar to stimulate the housing market (and any other market of big-ticket items that required borrowed money).  If we re-link the dollar to gold things like this couldn’t happen anymore.  For if it would put a short leash on the Federal Reserve and their ability to print dollars.  How?  As they print more dollars the value of the dollar falls.  Causing the value of gold priced in dollars to rise.  So they would have to stop printing money to keep the value of gold priced in dollars from rising beyond the established gold price.  Or they would have to remove dollars from circulation to decreases the value of gold priced in dollars back down to the established price.  Thereby giving us a stable currency.  And stable housing prices.  For having a stable currency limits the size of bubbles the Federal Reserve can make.

But governments love to print money.  Because they love to spend money.  As well as manipulate it.  For example, depreciating the dollar makes our exports cheaper.  But those export sales help fewer people than the depreciated dollar harms.  But helping a large exporter may result in a large campaign contribution.  Which helps the politicians.  You see, a stable dollar helps everyone but the politicians and their friends.  For printing money helps Wall Street, K Street (where the lobbyists are in Washington DC) and Pennsylvania Avenue.  While hurting Main Street.  The very people the politicians work for.

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More of the Same from the Fed means more Housing Bubbles and Great Recessions

Posted by PITHOCRATES - April 14th, 2013

Week in Review

Those who wanted to get away from the United States’ limited government past and grow government had to do away with the gold standard.  Those who favored a large and expansive federal government needed fiat money.  They needed the power to print money at will.  To fund deficits when they continually spend more than they have.  Despite continuously raising taxes.  When Nixon decoupled the dollar from gold in 1971 the fiat money people got their way.  Now the Keynesians could tax, borrow, print and spend to their heart’s content.  With the federal government in the driver’s seat of the U.S. economy.  With their Keynesian economists advising them.  Who said government spending was just as good as private spending.  So go ahead and tax, borrow and print.  Because all you need to create economic activity is to print money.

Of course they couldn’t have been more wrong.  As the Seventies proved.  Printing money just created inflation.  Higher prices.  And asset bubbles.  With no corresponding economic activity.  Instead there was stagflation.  And a high misery index (the inflation rate added to the unemployment rate).  Because there is more to economic activity than monetary policy.  Tax rates and regulations matter a whole heck of a lot, too.  As well as a stable currency.  Not one being depreciated away with double-digit inflation.  Rich people may get richer buying and selling real estate and stocks during periods of high inflation but working class people just see both their paycheck and savings lose purchasing power.

It was these Keynesian policies that caused the S&L Crisis.  The dot-com bubble.  And the subprime mortgage crisis.  Giving is the Great Recession.  The worst recession since the Great Depression.  But have we learned anything from these failed policies of the past?  Apparently not (see Blind Faith In The Fed Is Not Enough by Comstock Partners posted 4/12/2013 on Business Insider).

The move of the S&P 500 into new all-time highs is based on neither the economy, nor earnings, nor value, but almost completely on the blind faith that the Fed can single-handedly flood the market with enough funds to keep the illusion going.  In this sense the similarity of the current stock market to the dot-com bubble of the late 1990s or the housing bubble ending in 2007 is glaring…

Real consumer spending has been growing at a mediocre 2% rate over the past year despite growth of only 0.9% in real disposable income over the same period.  This was accomplished mainly by decreasing the savings rate to only 2.6% in February, compared to rates of 7%-to-11% in more prosperous times.  With employment growth diminishing and the negative effects of the January tax increases and the sequester yet to kick in, consumer spending is likely to slow markedly in the period ahead.  While March year-over-year comparisons may benefit from an earlier Easter, the reverse will probably be true in April.  Keep in mind, too, our over-riding theme that consumers, still burdened with most of the debt built up in the housing boom, are in no shape to jump-start their spending…

In sum, the lack of support from the economy, earnings or valuation leaves the Fed as the only game in town.  Although the old adage says “Don’t fight the Fed”, it did pay to fight the Fed in 2001 and 2002 and again from late 2007 to early 2009.  In our view, the Fed can only try to offset the tightness coming from the fiscal side, but cannot get the economy growing on a sustainable basis.

The only real growth we had was from a tax cut.  Surprise, surprise.  Of course that cut in the tax rate of the Social Security payroll tax decreased the Social Security surplus.  Moving the Social Security funding crisis up in time.  That along with Medicare and whatever Obamacare will do will cause a financial crisis this country has yet to see.  Which will cause great suffering.  Particularly because people are saving less because they have less.  Which is the only way they can compensate for the horrible economy President Obama and his Keynesian advisors are giving us.  So they won’t have private savings to replace their Social Security benefits that the government will spend long before they retire.

And what does the government do?  Why, spend more, of course.  Because of the sweet nothings their Keynesian advisors are whispering into their ears.  Saying the things big government types want to hear.  Spend more.  It’s good for the economy.  If you wonder what got Greece into the mess they’re in this is it.  Spending.  And anti-business policies to pull more wealth out of the private sector so the government can spend it.

All the countries reeling in the Eurozone sovereign debt crisis are there for the same reason.  None of them got into the mess they’re in because they had low taxes and low regulatory costs.  Because countries with business-friendly environments create private sector jobs.  And private sector jobs don’t cost the government anything.  So they don’t have to tax, borrow, print and spend like they do when they listen to their Keynesian advisors.  Because that is what causes chronic deficits to fund.  And growing national debts.  Things that don’t happen when you leave the economy in the private sector.

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Why the Deficit and the Debt Matter

Posted by PITHOCRATES - March 25th, 2013

Economics 101

Keynesian Economists say there is Nothing Wrong with Running a Deficit or a Growing National Debt

We had the sequester.  Before that it was the fiscal cliff.  Before that it was the debt ceiling debate.  We hear these things.  But it’s like water off a duck’s back.  It doesn’t sink in.  We hear but we don’t understand it.  In one ear and out the other.  In fact people are tired of hearing of how we go from one financial crisis to another.  Enough already the people say.  Enough.  Pity, really.  As there are some serious consequences to the decisions our politicians are poorly making.

Part of the problem is that these economic issues are difficult to relate to for average Americans just trying to take care of their families.  A trillion dollar deficit?  A debt reaching $16 trillion?  A lot of people don’t know the difference between the deficit and the debt.  Including many of our television news talking heads.  And then the sheer magnitude of the word ‘trillion’ is just difficult to fathom.  We know it’s big.  But no one uses it in their personal lives.  We know a $200 utility bill is expensive.  An $8,000 property tax bill is expensive.  A $40,000 car is expensive.  But a trillion dollar deficit?  It is hard to make a connection to the size of a trillion dollars.

Compounding the problem are all these Keynesian economists who say there is nothing wrong with running a deficit.  Or the growing national debt.  Despite the financial debt crisis in the Eurozone.  Where running a deficit and growing national debt have caused great problems.  But the Keynesians say that can never happen here.  Because our economy is so much larger.  And the U.S. can still print money.  So people don’t know what to believe.  The government and their economists sound like they understand this stuff.  While a lot of people don’t.  So the people who don’t are more inclined to believe those who sound like they understand this stuff.  Which makes it easier for the politicians who are making all of these horrible decisions to make even more of them.

Over time Interest Charges run up the Outstanding Balance on our Credit Cards

So to understand deficits and debt it would be better to bring it down to our level.  And once we understand it at our level then we can understand better what’s happening at the national level.  So let’s do that.  Let’s imagine a person earning $30,000 a year.  Or $2,500 monthly.  Let’s further assume this person’s earnings are not enough to support their lifestyle.  So they turn to their credit card each month for an additional $100 in spending.  Which is this person’s deficit.  The amount they spend over what they earn.  Or money they spend that they don’t have.  So they charge it.  For this example we’ll assume a credit card with a 24% annual percentage rate.  In the following table we crunch these numbers for 120 months.  Or ten years.

Personal Deficit Spending and Cummulative Debt R2

The columns in the table are fairly self explanatory.  Each month we start with $2,500.  We start borrowing money in month 1 so there is no interest in the first month.  We subtract the interest from the monthly income to arrive at income less the interest charge on the credit card.  Our spending budget each month is $2,600.  Requiring $100 in credit card purchases in the first month.  Each month this increases by the amount of interest charged each month.  The last column is a running total of the credit card balance.

Over time the interest charges run up the outstanding balance on the credit card.  Because we are paying interest on both our purchases and our interest.  So as time goes by this increases our credit card balance at an increasing rate. Soon the interest charges take a larger percentage of our monthly income.  So much so that we need to borrow more and more to maintain our current level of spending.  The interest charge on the 120th month equals 38% of our monthly income.  Chances are that it would never get this bad as we would be unable to make our monthly payment long before the 120th month.  And with an outstanding debt approaching our annual income we probably would have filed for bankruptcy protection long ago.  For at these interest rates it wouldn’t take long before that debt grew beyond our ability ever to pay it back.

Deficit and the Debt Matter because Income is Limited

We can see this better if we graph these numbers.  We can see the cumulative debt growing at a greater rate over time.  Just as does the percentage of our personal income going solely to paying the interest on our debt.  Truly wasted money.  Spending money for things we purchased long ago.  And if we spent it on restaurants and vacations we have nothing tangible to show for this.  Nothing we can sell to get our money back.  Just interest payments that seem to go on forever and ever.  For something that gave us a few hours or days of pleasure.  Which is the worst kind of debt to have.  As there is no way to pay it down other than with current earnings.  Meaning we have to make sacrifices today and tomorrow for spending we did long, long ago.

Personal Income Debt and Interest as Percent of Income R1

On the chart we have a horizontal line for monthly income.  And one for annual income.  We can see that it only takes 21 months for our credit card balance to exceed our monthly income.  Not even two years.  But only 1.9% of our monthly income is going to pay for interest on the debt.  Which doesn’t sound that bad.  So we keep charging.  Just after three years of doing this we break $100 in interest expense.  Requiring 4.2% of our earnings to go to pay the interest on the debt.  It only takes another 2 years to break $200 in interest expense (8.4% of earnings).  It only takes another year to bring the interest charge to $300 (12.3% of earnings).  In 99 months the interest charge breaks $600 (24% of earnings).  And the total outstanding credit card debt is now greater than our annual earnings. Making it very unlikely that we’ll ever be able to pay this balance down.

Anyone who charged a little too much on their credit cards knows what this feels like.  And what those phone calls from collection agencies are like.  Not good.  Anyone who charged anywhere near this example no doubt brought great stress into their lives.  They might have lost their house.  Their retirement savings.  Their kids’ college funds.  Or had no choice but to file a personal bankruptcy.  But when we run our debt up this high there comes a point where we cut up the credit cards.  Making a serious cut in our spending.  Because that’s all we can do.  We can’t just earn a lot more money.  And we can’t print money.  If we could do either we would not have a debt problem in the first place.

This is where average Americans and the federal government differ.  Average people have no choice but to be responsible.  While the federal government can allow the problem to grow and grow.  For they can arbitrarily raise their income.  By raising taxes.  And they can print money.  Unfortunately for average Americans both of these options make life worse for them.  Raising taxes makes us cut our personal spending as if we ran up our credit cards.  Forcing us to get by on less.  And printing money causes inflation.  Raising prices.  Which, of course, forces us to get by on less.  This is why the deficit and the debt matter.  For income is limited.  Whether it’s ours.  Or the federal government’s.  And when you spend more than you have more money goes to paying interest on the debt.  Which is money pulled out of the economy and thrown away.  The ultimate cost of spending money you don’t have.  Money thrown away.  And, of course, potential bankruptcy.

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Off-Budget Social Security Surplus

Posted by PITHOCRATES - February 18th, 2013

Economics 101

Because we have Limited Income we Prioritize our Expenses

We all want more than we can afford.  We may want to drive a brand new Lincoln MKT but can only afford a used Focus.  So we drive a used Focus.  We may want to live on the beach in Southern California but can only afford a 2-bedroom apartment in Pasadena.  So we live in a 2-bedroom apartment in Pasadena.  We may want to dine on filet mignon and champagne every night but can only afford Hamburger Helper and a store-brand soda.  So we dine on Hamburger Helper and store-brand soda.

In life we have to make choices.  And live within our means.  So we budget our money. We list all our income.  And all of our expenses.  Breaking down the expenses in order of importance.  Rent is more important than cable television.  The electric bill is more important than stopping at Starbucks every morning for a Venti Caramel Macchiato.  The gas bill is more important than unlimited texting.  Because we have limited income we prioritize our expenses.  Those most important we budget to pay first.  Those less important we enjoy when we have some disposable income left over.  After paying everything that is more important first.

This is responsible living.  Which a lot of people do.  Live responsibly.  While some don’t.  And use credit cards to buy things they can’t afford.  Or they do a little work on the side ‘under the table’ for some extra spending cash.  Money they don’t report as income so they don’t have to pay income taxes on it.  Because like Billy Joel said you can pay Uncle Sam for the overtime.  Or not.  And a lot of people choose not.  Interestingly, a lot who do are die-hard Democrats who want to raise tax rates on the rich.  But when it comes to their hard-earned money they want to hide it from Uncle Sam.  But I digress.

Social Security Taxes are Dedicated for One Thing—Social Security Benefits

We can call money we earn on the side off-budget money.  We don’t add this money to our household budget.  It’s special money to spend on things we enjoy.  For if a husband does some plumbing work on the side his wife may want to use that money to pay down a credit card balance.  Or spend it on new window treatments.  While he may have other ideas for that money.  Maybe some new fishing equipment.  Or a new power tool.  Or maybe using it to go tailgating with the boys.  That money could buy a lot of food to barbecue.  And a lot of beer.  Things that are a lot of fun.  While paying down a credit card balance is not.  Just as window treatments are not.

So by keeping this money off-budget he can use it for what he originally intended it for.  Him having fun.  Keeping the money off the family budget prevents anyone from using those targeted funds for some other unintended purpose.  Preventing out of control spending growth on other less important things.  He is actually doing the family a favor by hiding this money.  Or so he rationalizes.  Because hiding it prevents his family from spending too much money.  For let’s face it if you have that additional money you’re going to budget it on something.  You may even commit to some long-term spending obligation.  Like buying a new Lincoln MKT.  Which will be a problem if the husband throws out his back doing all of those side jobs and goes on disability.

Another example of off-budget money is Social Security.  Specifically, the Social Security surplus.  Contrary to the government calling it a retirement investment it is not an investment.  The government collects Social Security tax revenue.  And pays Social Security benefits from that tax revenue.  What’s left over is the Social Security surplus.  (Until it becomes the Social Security deficit.)  And they put it into the Social Security Trust Fund.  Outside of the regular budget.  So they can’t spend it on other things.  And any budget negotiations won’t affect it.  For employers and employees pay into Social Security.  And this is the money we get back in benefits.  Those benefits are not budget items paid from all the other taxes the government collects.  That pay for things from defense spending to food stamps.  No.  Social Security taxes are dedicated for one thing.  Social Security benefits.  Which is why they moved it off-budget.

If the Deficit is Consistently Understated there will be no Money to Redeem the Securities in the Social Security Trust Fund

But that doesn’t stop the government from spending that money.  Just like so many unions have underfunded pension plans so, too, government can’t resist the allure of a great big pile of money.  Because it’s just sitting there.  Not being spent.  Something that just pains a politician to no end.  Unspent money.  But because it’s off-budget they just can’t spend it.  They have to borrow it first.  So the money goes into the Social Security Trust Fund.  They then remove the money from Social Security Trust Fund.  And leave behind an IOU.  Treasury securities.  Backed by the full faith and credit of the United States.

So even though that money is dedicated for Social Security benefits and is strictly hands-off for other spending the government spends it on other things.  And it works out pretty well for the government.  Not only do they get a little extra money to spend it helps conceal the extent of their other spending.  For this off-budget money decreases the budget deficit.  Caused by all of that on-budget spending.  That far exceeds their ability to pay for it.  To illustrate that see the following table.  This is a very simplified fictional federal budget.  We have tax receipts.  And federal outlays.  Broken down into two general categories.  Guns and butter.  That’s defense spending.  And everything else.  Note how if they leave the Social Security surplus alone (without) there is a deficit of 47%.  But if they borrow that money (with) it reduces the deficit to 10%.

Social Security Surplus Off-Budget

When they talk about the budget deficit it includes the Social Security surplus.  That money is dedicated for one thing.  Social Security benefits.  They’re not suppose to use it for anything else.  So they shouldn’t count this revenue in the budget that pays for everything else.  When they do they understate the true budget deficit.  Worse, the money in the Social Security Trust Fund does not earn a return on investment.  Like with a 401(k).  Yes, there are Treasury securities in the trust fund.  But a government that is consistently understating their true deficit will never have the money to redeem those securities.  So they will do the only thing they can.  Print money.  Which is what they mean by the full faith and credit of the United States.  Print money.  Causing inflation.  And raising prices.  Making that meager Social Security benefit buy less.  Not to mention that Social Security itself will soon be insolvent.  Thanks to the growth in all of that other spending.  That is growing so great that they continually need to raid the Social Security Trust Fund to pay for it.

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Double Entry Bookkeeping, Trial Balance, Financial Statements, Financial Ratios, Italian City-States and Capitalism

Posted by PITHOCRATES - January 8th, 2013

History 101

The Government Finances are a Train Wreck because they have the Power to Tax and to Print Money

President Obama averaged a deficit of $1.3 trillion for each of his first 4 years in office.  Bringing the national debt up to $16.4 trillion at the end of 2012.  And there will be another drop-down, drag-out fight to raise the debt limit in a couple of months.  Why does the government spend this kind of money?  Because they can.  And because they can they can buy a lot of votes by giving stuff away.  Stuff paid for with all of that spending.

When the government implemented Social Security and Medicare there was still an expanding birthrate.  More people were entering the workforce than were leaving it.  Providing an ever expanding tax base.  And a rising level of tax revenue.  Without ever having to increase tax rates.  And the smart government planners thought the good times would just keep rolling.  But they didn’t.  Thanks to birth control and abortion.  Which reversed the equation.  The population growth rate slowed down.  Fewer people entered the workforce than left it.  Resulting in a declining tax base.  And falling tax revenue.  Pushing Social Security and Medicare to the brink of bankruptcy.

The government finances are a train wreck.  And they keep digging their hole deeper.  Because they can.  For they have the power to tax.  And to print money.  Something private businesses can’t do.  Which is why few corporations’ finances are train wrecks.  Except those with unionized workforces with defined-benefit pension plans.  Something long discontinued by most in the private sector.  As it’s a failed economic model.  Just like Social Security.  And Medicare.  Over time more people move from being contributors to being beneficiaries.  Pushing defined-benefit pension plans, too, to the brink of bankruptcy.

At the End of each Accounting Period they run a Trial Balance to Verify the Total of Debits Equals the Total of Credits

The difference between private sector businesses and the federal government is that private sector businesses have to be responsible while the federal government does not.  The federal government focuses on what’s politically expedient.  While private sector businesses must focus on the bottom line.  Spending only the money they have.  Because they can’t tax or print money to fix their messes.  Like the government can.  And does.  A lot.  So they have to avoid making messes in the first place.  They can’t kick the can down the road.  Because in the private sector there is accountability.  And that accountability begins with getting their hands around their business numbers.  So they can understand what their businesses are doing.  And when it’s time to take appropriate actions.  To prevent a financial train wreck.  And it all begins with double-entry bookkeeping.

Double-entry bookkeeping includes debits and credits.  Each transaction is posted to the accounting records with at least one debit and at least one credit.  The dollar amount of debits equals the dollar amounts of credits.  If they don’t equal after recording a transaction they were posted incorrectly.  For example, when someone pays cash for something at a retail store there are two debits and two credits to post.  First we debit cash $20 and credit sales revenue $20.  Then we debit cost of goods sold $18 (the cost of the item sold) and credit inventory $18 (the cost of the item in inventory).   If posted correctly the total debits equal $38.  And the total credits equal $38.  If, for example, someone debited sales revenue instead of crediting sales revenue the total debits would equal $58 while the total credits would equal $18.  Because they don’t balance we know something was posted incorrectly.  And can go back, find the error and correct it.

A business accounts for every penny that flows through their business.  Each accounting period will have thousands of such entries.  And at the end of each accounting period they will run a trial balance to verify that the total of debits equals the total of credits.  When they do they can be pretty sure that the financial information they recorded fairly represent the financial activity of the business at the end of that accounting period.  Then they prepare the financial statements (the income statement, the balance sheet, the statement of cash flows and the statement of retained earnings and stockholders’ equity).  Businesses study these statements to assess the health of their businesses.  They calculate financial ratios to assess the liquidity, long-term debt-paying ability and profitability of the business.  As well as calculate ratios for investor analysis.  To make sure they are satisfying the owners of the company.  The stockholders.

The First Use of Double-Entry Bookkeeping dates back to the Italian City-States of Florence, Genoa and Venice

This is a lot of valuable information.  Courtesy of that double-entry bookkeeping.  Something that can be so mundane and mind-numbing at the data entry point.  Especially if you’re trying to figure out why your trial balance doesn’t balance.  But when it does balance.  And the financial information is fairly represented.  Business owners and managers can make informed decisions to avoid doing what our federal government does.  Including making the hard decisions that permit these businesses stay in business for a decade or more.  Even a century or more.  Thanks to merchant banking.  And the Italian city-states.

For those of you who hate bookkeeping blame the Italians.  Some of the Florentines were using it as early as the 13th century.  The Genoese were using it shortly thereafter.  Soon Florence, Genoa and Venice were using double-entry bookkeeping.  This mastering of economic data made these city-states the dominant economic powers of the Mediterranean.  Making them masters of trade.  And merchant banking.  To manage that trade.  This system of accounting even made it into textbooks in the late 1400s.  Helping to spread good business practices.  Where they were picked up by other great traders.  The Europeans.

With double-entry bookkeeping businesses were able to grow.  First with the help of government.  Mercantilism.  Then without.  Free market capitalism.  Which created the British Empire.  And gave us the Industrial Revolution.  Then the United States came into their own in the late 19th century.  And surpassed the British Empire.  Economic activity exploded in the United States.  Because they were able to get their hands around all of those financial numbers.  And thanks to free market capitalism they focused on the bottom line.  And made the necessary decisions.  No matter how painful they were.  Something that the federal government just can’t do.  Because those decisions aren’t politically expedient.

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