February 12, 2016

Accounting for dummies

Comment on David Ruccio/Liam on ‘Why is slow growth a problem?’


You say “This is a cost-accounting problem. Period. End of story. Any attempt to make it more complicated than that is intellectual masturbation IMO.”

Agreed, let us treat it as an accounting problem. And let us de-complicate the economy to the bare bones.#1

The most elementary economy is the production-consumption economy and it consists of the business and the household sector. For a start, the business sector produces and sells one consumption good. The business sector is fully integrated from the intake of raw material to the output of the final product. With one giant firm, we have the simplest of all possible cases.

First period: the business sector pays 100 monetary units (million, billion, trillion Euro, Dollar, Yuan) to the household sector and the household sector spends exactly this amount on consumption goods. There is no saving of the household sector. The business sector’s profit is zero and the price of the consumption good is equal to unit wage costs. The real wage is equal to productivity.

For the economy as a whole, there is no gap. The business sector fully recovers its wage costs. This can happen at ANY level of employment, so full employment is no problem. However, problems can arise on the monetary side. If employment is doubled, for instance, then wage income doubles and this means that transaction money must double. In a well-designed economy, the central bank can provide the necessary transaction balances out of nothing.

Interim result: it is possible in principle to run the elementary production-consumption economy at any level of employment and to grow or shrink at will, provided the central bank finances the wage bill whatever it is. The business sector makes neither profit nor loss. The economy is reproducible for an indefinite number of periods.

Second period: the household sector saves 10 monetary units (S=10) and spends 90 units. Now, the business sector makes a loss (Q=−10). The market-clearing price is lower than unit wage costs. There is no change in inventory.

Accounting result: saving=loss  [Q≡−S]. The complementary notion of saving is NOT investment but loss. If the household sector dissaves 10 monetary units (S=−10), i.e. spends 110, then the business sector makes a profit (Q=10). So growing household sector debt is the ULTIMATE source of profit (NOT productivity increases, NOT risk-taking, NOT wage-cutting, NOT firing people, NOT the other brain-dead common sense explanations from the microeconomic ant-perspective).

At the central bank’s balance sheet we have in the case of pure credit money at the end of the 2nd period 10 units of current deposits of the household sector and the equal amount of current overdrafts of the business sector in the case of saving. Without going further into details it should be obvious that the rate of interest on the asset side and the rate of interest on the liability side must be such that their difference covers the wage costs of the central bank under the condition of zero profit. Again, there is no gap or problem if the economy is well-designed. Needless to emphasize that it is actually NOT well-designed.

How to organize a well-functioning economy is a question neither orthodox nor heterodox economists have figured out in more than 200 years. No question, if there is something like a scientific hell Walrasians, Keynesians, Marxians, and Austrians will be dammed to discuss their proto-scientific garbage in eternity with dull Econ 101 students as the sole audience.

Takeaway: you have to thoroughly rework your website. Flag-waving is not a substitute for thinking or proper accounting.

Egmont Kakarot-Handtke

#1 For the formal underpinning see the post Economists cannot do the simple math of profit — better keep them out of politics or the SSRN working paper Economics for Economists

Related 'Have data, lack theory' and 'The common error of common sense: An essential rectification of the accounting approach' and 'A tale of three accountants'. For details of the big picture see cross-references Accounting.


REPLY to Liam of Feb 12 on Feb 13

First, you say “This is a cost-accounting problem. Period. End of story. Any attempt to make it more complicated than that is intellectual masturbation IMO.”

Next, you say “I won’t agree to your FIRST model because it is so far from reality that it is hardly worth commenting on.”

So, you first ask for a simple picture of the economy and when you get the simplest possible picture you complain that a lot of details are missing. This is the outworn catch-22 schizo that is endemic in economic discussions (2013).

If you had done your homework and looked into some of my working papers you would have realized that the elementary consumption economy has already been differentiated in ALL directions. So, (i) your ‘realism vs. abstraction’ kindergarten game falls flat, and (ii), you make it quite clear that you are not aware of the basics of methodology: “There can be no doubt whatsoever that a problem which has not yet been solved in all its aspects under its simplest conditions will be still more difficult to tackle if other, ‘more realistic’ assumptions are being made.” (Morgenstern, 1941, p. 373)

With regard to your challenge, the error/mistake is already in the first line. You write “A = all cost components of price comprised of wages, earnings or dividends.” Note that dividends are not a cost component. Better if you get your price theory right first (2011).

Advocating social credit is one thing, and claiming that it is based on sound economic theory is quite another thing — in your case, it is definitely not.

You make the same mistake as standard economics, that is, to start with an agent/firm and to go bottom-up, i.e. microfoundation, leads to nowhere, yet to start with the economy as a whole and then to go top-down, i.e. macrofoundations, yields consistent and testable propositions. Every economist could know this by now from the evident failure of Walrasianism.

Kakarot-Handtke, E. (2011). The Emergence of Profit and Interest in the Monetary Circuit. SSRN Working Paper Series, 1973952: 1–22. URL
Kakarot-Handtke, E. (2013). Confused Confusers: How to Stop Thinking Like an Economist and Start Thinking Like a Scientist. SSRN Working Paper Series, 2207598: 1–16. URL
Morgenstern, O. (1941). Professor Hicks on Value and Capital. Journal of Political Economy, 49(3): 361–393. URL


REPLY to Liam on Feb 14

I have no problem at all with CH Douglas’s political program, I have only a problem with his underlying economic theory. The point is: right policy depends on true theory. If you intend to fly to the moon you first have to figure out the law of gravity (and some others). If you want to improve the economy you first have to figure out how it works.

This is an economics blog and in my understanding, the uppermost goal is to replace standard economics, which is provably false, with the true economic theory.

“In order to tell the politicians and practitioners something about causes and best means, the economist needs the true theory or else he has not much more to offer than educated common sense or his personal opinion.” (Stigum)

Economists do not have the true theory. Neither Walrasians, nor Keynesians, nor Marxians, nor Austrians, nor Douglasians know how the economy works. So they are in no position to promise a ‘better’ economy. Worse, with false economic theories in their scientifically incompetent micro brains, economists actually cause or worsen crises.

How convincing are economists who promise to create the Good Society but cannot do elementary accounting? To recall, the profit theory has been false since Adam Smith. Economists literally do not know what they are talking about.

So: first get economics right, then get the economy right.


REPLY to Liam on Feb 16

“...the tens of thousands (millions over the past century) of people” who stand with you are certainly a veritable political force but they have no say in scientific matters. Science is about logical and empirical proof.

If you can refute my main point, let me know.

And this is the main point: You cannot tell the difference between profit, income, and distributed profit and because of this, you have no idea about how the actual economy works.