Saturday 11 October 2008

The Wall Street story

The events on Wall Street are not only a symptom of a general malaise (see previous blog) but can be identified as certain specific functionalities going through their paces. In the process other domains become affected.

One benefit of using functionalities rather than content is the former's scalability, not so easily done with the latter. For example, a one kilogram iron bar requires a different neighbourhood than one weighing a tonne. But see them as a lever (a functionality) and that property can be applied regardless.

Since we can scale, let's start small. Consider the price of wheat per kilo and compare it with the price of bread of the same weight. Naturally bread costs more, reflecting the value-adding process it has undergone. If an economy were to consist of only two types of people, wheat growers and bakers, we have a problem with the generation of wealth. It is not enough to sell wheat and bread. If money is required to take care of things other than those two, for every unit of wheat grown and sold, and for every unit of bread baked and sold, there needs to be enough left over from the profits to pay for everything else. But how can this happen unless one party decides to up the price unilaterally and thereby condemn the other to perpetual bare survival. Such a situation cannot last.

So let's widen our model and add other materials and products and their respective generators. For the system to work the unit price of every good (and any associated service for that matter) must be such that, firstly, enough is left over for 'everything else' but secondly, some unit prices must be higher than others in order to introduce the differences necessary for someone's purchasing power to cover the scope of goods that economy is able to offer. (By the way, here are the underlying reasons why demographics featuring a small number of products can never be as wealthy as their more diverse counterparts - unless of course artificial loading is imposed from the outside)

A goldsmith, say, operates with different unit prices altogether as far as their raw materials and the end products are concerned. The proceeds from one gold ring buys many loafs of bread, and the baker needs a relatively broad customer base in order to afford jewellery. Add as much variety of materials and products as you wish, in principle the same relationships hold. There must be a general difference in unit prices across the spectrum to enable the proceeds to widen their usefulness in tandem with the richness of the entire economy.

But unit prices alone are not enough. Not only is a gold ring worth more than a loaf of bread, the output per time units of a goldsmith can be less than that of a baker and profits can still be realised.

What about the bottom rung in our model so far? Wheat growers do not necessarily come last because selling a lot of wheat takes care of the hierarchy in terms of unit prices per se. As long as the relationship in numbers between farmers and food processors is a reasonable one, the equation holds overall.

These two entities, price units and time units, can be combined for any commodity, let's call it the product unit. The discrepancies between product units (price- and time-wise) across an economy allow profits to be made, simply because there is always some price in relation to some other, and there is always some time period in relation to some other, which produce an oversupply of value (represented by money) such that some other product can be purchased.

So far we have assumed a certain intent to keep the system in balance. That view is improbable given human nature and the sheer resources needed to administer any transgressions. Most people will want to increase their profits, either through producing more or through jacking up the price. However, there are ultimate limits represented by the size of the market and its willingness to pay. Generally speaking the system settles into a balance more or less due to those factors. Nevertheless, a greater variety of products and a greater number of operators increase the chances of useful differences and hence profit making. It also means that there always will be a hierarchy of profitabilities regardless what certain idealists may wish for and regardless of the means of exchange, be that money, services, or status.

Suppose now someone wanted to work around these barriers. There are two options. Come up with a new product entirely and - for some time at least - it will have placed itself outside the dampening cycle of interacting pre-existing product units. Invent the light bulb and for the moment you have the market to yourself.

That option, although effective, is time and resource consuming and therefore not readily available (but it does exist).

Another option is to come up again with a new product, but this time one which is cheaper to implement. Remember the relationships between product units, all based on the exchange of their respective values, and made possible through our means of exchange, that is money.

If you view money itself as yet another product, the same interdependencies of price and time units can be applied. All you need to do is insert a process dealing with money alone into the flow and the same principles hold.

This is exactly what happened over the last few decades. Actually, one can argue the appearance of financial instruments started with the invention of paper money in China, or cheques by the Hanse, or, for that matter, the manipulations by the US Federal Reserve Bank early in the 20th century as the move away from the gold standard started to take hold there.

Still, whatever the performances of monetary product units may be, as long as the link between their dynamics and those of the other product units they in the end represent is not too tenuous the system will still work, because their respective time factors (of both, the money-related products and the rest) fit into the overall spectrum of delay and/or availability of products.

However, widen the time spans and eventually the system will slow down or even grind to a halt; put simply, money takes too long to reach the areas where it is required to play its part in the product unit cycles.

Right now the insertion process of an ever growing number of money-related products and their associated processes has widened the gap considerably, so much so that the combined price and time units of those products the money is meant to represent in the end are no longer able to keep pace with the processes belonging to those newcomers. The results can be seen around the world.

In principle, the solution is simple: remove those artificial products and with them their processes. In practice there are dangers. They centre on the existing linkages between those products and the others in the rest of the economy. To find the path of least damage requires a considerable data base containing the instantiated effects of products and their neighbours. Knowing what to remove without affecting their dependencies (such as they are) requires a commensurate familiarity with the economic structure in all its detail. I doubt whether such a flow chart even exists, never mind its use.

On the other hand, the system itself ensures that unviable products are sooner or later left by the wayside in any case. Natural re-adjustments come at a cost however, and the damage can be seen every time an economic system purges itself. Nevertheless, an organised type of healing should be possible once we have made the effort of pairing the functional picture with its content-related counterpart. While not an easy exercise I would suggest its costs are insignificant compared to those of a meltdown.

Yet whatever happens, it isn't the end of the world.

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