As people work harder and are able to consume more using more and more technology, the question should be at what expense such demand is met. If it is met at the expense of Mother Nature and conversion of non-renewable natural resources using old technologies, such demand is unjustifiable, although cannot be yet accounted for based on modern accounting rules.
Back to the Future
Below are my recommendations that, in theory, should add transparency in the global financial and economic system, without jeopardizing the real business activity of its participants. While I completely understand that the feasibility of these measures will be challenged by many professionals, I should like to learn the arguments why this wouldn’t be a good judgment:
1. Use geometry to view economics.
Finding geometric shapes of the economic subjects (countries, businesses and individuals) brings transparency and understanding of the current state of affairs with potential to identify critical points in order to avoid crisis. While Economical Equilibrium is only a theory and substantial evidence needs to be collected, analyzed and challenged for consistency in every aspect of its application in economics, its main purpose is to identify angularity and forewarn those who don’t yet see problems coming.
Economical Equilibrium’s use in finance is a possibility to identify early warning signals and symptoms of when something is wrong and needs immediate action. For example, if there is no continued contribution by the participants of the economic system, but money continues to be printed or borrowed to maintain the standard of living that people have got used to, but can no longer afford, crisis is inevitable and respective geometric figures can assist in identification of respective issues.
Geometry will reflect only the status of processes in economics. Use of Economical Equilibrium tools, combined with recommendations below, should help bring things to balance and make the global economy work towards everyone’s benefit.
2. Switch GAAP to a cash (not historical cost, not fair value) basis.
Cash (money) is the only means of exchange, thus GAAP should record transactions on a cash basis only. Non-cash value, recorded on companies’ balance sheets, is elusive, adds volatility, uncertainty, and cannot be immediately converted to cash. I foresee multiple arguments against this position, but simple facts, such as that banks can circulate cash in the form of debt multiple times, shares can go up or down in price regardless of fundamental valuations and/or GAAP equity, should convince accounting professionals to challenge their existing rules. CVR and VRR could be used to a certain extent in order to approximate cash values.
3. Question interest recognition by the banks.
Interest, profit and value-add are a covert form of inflation. Banks should be relegated to their original purpose – depository institutions and money storage – when depositors pay a fee for securing their money. Banks are not owners of the money. When banks lend money, they risk their depositors’ money by frontloading obligations on future performance of someone else. This performance may not occur, thus causing ambiguity and distortions in economics. Paper and electronic money is a residue from previous exchange and should be managed by the money owner.
4. Question liquidity (money) supply mechanism, debt origination and money “spinning” in the banking system.
Money is a promise to receive future value. Lending money means lending promises to receive value in the future, thus multiplying chances of failure. But even without the theoretical justification of money lending abnormality, banks lend money that doesn’t belong to them to begin with (e.g. kept on current or deposit accounts) or worse, turn money around and thus gross up their balance sheets. When money lent is not returned to the banks due to otherwise inevitable financial crisis, governments tend to bail the banks out, thus causing even more distress for the financial system, because the bail out money comes either at the expense of tax revenue or government debt.
5. Question public stocks, bonds, derivatives and any financial instruments’ valuation on any basis other than cash in GAAP.
An asset price is not confirmed until it is sold. Fair value can change the very next day. Anything other than cash is subject to change in value. All financial instruments, including stocks and bonds, are derivatives of cash value, but don’t have much or any of it if sold at once. These derivatives were mistakenly assumed to appreciate in value through financial models based on a premise of perpetual growth, which is not possible.
I realize that this recommendation may never materialize due to the profit motive and speculation inherent in trading activities (which have nothing to do with fundamental business valuation and / or GAAP value of equity). Historical cost, not fair value, modified with CVR and VRR, could be the next best option to cash basis.
6. Savings and pensions should be in the form of cash, hard assets with high CVR and VRR, and cash generating assets only.
If the U.S. pension funds were to sell all of the stocks, bonds and other investments they possess today, the prices would tumble because there is not enough cash in the entire financial system to maintain their quoted market values. This follows from geometry of the current state of the stock market value distribution, where market quotes can increase due to a very small volume of trades. The idea of investing pension funds’ money in stocks and bonds needs to be reconsidered and new ways of wealth preservation must be found in line with the trends of global economics.
7. Government taxes should match wealth distribution.
Profits, measured with money, cause monetary inflation in expansionary economics and, ultimately, inequality in wealth distribution. Therefore, tax collections should be in the same proportions as wealth distribution.
Taxation of a profit makes sense when economic activity increases, because there’s extra money (monetary inflation) in the system, created by the increased contribution of natural resources and / or labor. When economic activity stabilizes and doesn’t grow, there is less profit to tax. This is where revenue starts to play an important role for tax purposes, because it represents what a willing party paid to the seller, and, as such, the seller earned the money from business activity.
By taxing revenue, a government stimulates business activity and exchange. Profits are impossible in a system when the contribution matches the demand and therefore sales tax becomes the best form of tax.
INSTEAD OF IN CONCLUSION
Our world is not ideal – it is a constant struggle for life at every turn. Nevertheless, intelligence should prevail over ignorance and misconceptions, dictated primarily by the previous mistakes we have made. After all, we should continuously evolve, not regress, and maybe someday we could enjoy a new paradigm of economics with no crises and shortcomings.
Any science is an exploration of the unknown, and that’s an endless frontier. While economics, accounting and finance recently have been on the radar of many professionals, little has been done to date to help people enjoy life without worrying about where their money is going, and how their wealth and well-being can be protected, especially in the fast-changing world we live in today. When we look at where we are today in terms of economics, there is no question in the minds of many economists that we need a different model, and Economical Equilibrium theory could be a good starting point.
If we want to have well-balanced economics, everyone should consume subject to their contribution, but be conscious at what expense such consumption is made in the first place. The ideal shape of the economic pattern would be a circular shape, when people contribute and receive the earned demand in return.
Finally, a warning to all of us from Critique of Pure Reason by Immanuel Kant: “It is, indeed, the common fate of human reason in speculation, to finish the imposing edifice of thought as rapidly as possible, and then for the first time to begin to examine whether the foundation is a solid one or no. Arrived at this point, all sorts of excuses are sought after, in order to console us for its want of stability, or rather, indeed, to enable us to dispense altogether with so late and dangerou
s an investigation.”
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ABOUT THE AUTHOR
Mr. Ilya Vladimirovich Kuntsevich was born in Belarus (former USSR), grew up in Moscow, Russia, and lives and works in Los Angeles, United States. He has a Bachelor’s degree in Economics from Financial University under the government of the Russian Federation, and MBA from UCLA Anderson School of Management. Mr. Kuntsevich is a Certified Public Accountant (Inactive).
Mr. Kuntsevich specializes in international finance, economics and investing in early stage companies.
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[1] Excluding services as living standards are maintained primarily by exploitation of natural resources, and resulting consumption of goods.
[2] “The last days of Bear Stearns” Roddy Boyd, CNN Money
[3] http://www.occ.gov/news-issuances/news-releases/2012/nr-ia-2012-88a.pdf
[4] http://www.federalreserve.gov/releases/h3/current/H3.pdf
[5] http://www.bea.gov/iTable/iTable.cfm?ReqID=9&step=1#reqid=9&step=3&isuri=1&903=35
[6] Macroeconomic Patters and Stories. Edward E. Leamer © 2009
[7] http://www.usgovernmentrevenue.com/year_revenue_2012USbn_13bs1n_103011#usgs302
[8] “Macroeconomic Patterns and Stories”, Edward E Leamer © 2009
[9] World Gold Council, Interactive gold price chart
[10] U.S. Energy Information Administration data
[11] M0 includes the bills and coins in people's pockets and mattresses, the money on hand in bank vaults and all of the deposits those banks have at reserve banks
M1 represents all of the currency in the M0 money supply, plus all of the money held in checking accounts and other checkable accounts, as well as all of the money in travelers' checks.
M2 is the M1 supply, plus all of the money held in money market funds, savings accounts and small CDs.
Market capitalization (also known as market value) is the share price times the number of shares outstanding.
[12] http://www.federalreserve.gov/releases/h6/current/h6.htm
[13] http://data.worldbank.org/indicator/CM.MKT.LCAP.CD
[14] http://www.federalreserve.gov/releases/h6/current/h6.htm
[15] IMF World Economic Outlook Database
[16] SIFMA data
[17] http://www.bloomberg.com/markets/rates-bonds/corporate-bonds/, March 26, 2013
[18] IMF World Economic Outlook Database
[19] Since money is introduced into the financial system by being printed or made available electronically, it has a relative, not an absolute, value. As such, both CVR and VRR, when applying Spot Cash Value, should take monetary inflation into account.
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