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Making market forces work

Jun 11 2014 07:21
*Edward Ingram
TWO weeks ago I commenced summarising the principles of good macro-economic design – how the working parts of an economy should be constructed, and how the economy should be managed.

I explained what the preservation of wealth is, and how to practise it. Wealth can only be preserved in liquid or semi-liquid (accessible) form as savings or an investment in bonds. In other words, by lending it.

For that to be done safely, the borrowing and the level of repayments must also be safe. The borrower’s task is to repay the wealth borrowed plus some market-related interest at an affordable and stable rate.

If done correctly as per my Mark I economic model, all wealth, debts and repayment rates as well as interest rates (if not distorted by other things – which I will deal with next) will respond to any change in the rate of average incomes/earnings growth, AEG% p.a.

In that case, there will be no sudden changes to costing and no major changes to spending patterns or threats to wealth, no matter what interest rates or inflation rates are doing. Everyone will be able to continue what they were doing before the interest rate or the inflation rate changed.

This is a self-rebalancing economy. It does not lose its balance when the inflation rate changes, except insofar as some things happen before others and there may be some interference from international trade creating extra, or reduced, demand, which I deal with in my Mark III economic model below.

So the principle here is to keep the economy in balance when those things that we cannot control change, and in particular, when the level of demand from rising or falling incomes is altered for whatever reason.

Employment and spending will continue as before, just at a different level of money-cost and income. In my Model I economy, market forces are free to make these adjustments so that is what will happen: as incomes rise, money loses value and everything adjusts accordingly, even interest rates.

The next principle that I suggest we should follow is to replace the interest rate instrument used by central banks for the management of the money in circulation with an instrument that creates the precise amount of money for lending and spending that the economy, in their view, needs at any one time.

The interest rate, being a price, should be left to do what prices are supposed to do – balance the demand for the now precise level of money supply to lend with the amount that is available.

If there is too little money, then more should be created. This should be passed on to every spender in the economy in the form of a subsidy or a discount on all spending that everyone and every institution -  including governments - are doing so that again, the spending in the economy is kept in balance.

There will not be a Keynesian distortion in spending patterns, nor a Keynesian debt to pay off after any stimulus.

Swiss referendum on money creation

There is a referendum being sought in Switzerland. If it goes through with 100 000 votes, the constitution will in future allow only the central bank to create money. This is the same idea, but how it is used may be critical. I am hoping to influence the detailed outcome.

Finally, for my Mark III economic model, the value of the currency should reflect the balance (or imbalance) of trade so as to steer all economies towards a balance of trade. I followed some more basic principles when looking at the structure needed to do that.

Firstly, I separated international investment flows from trade flows so that the latter does not interfere with the pricing of the currency. The currency price will then be used to create a balance of trade.

Secondly, in doing this I prevented incoming and outgoing investments from coming in and going out with additional money – for otherwise it would create a level of demand in the economy that exceeds what could be supplied.

The Swiss need to take note of this. The international part of the economic model has to work without impacting on the domestic money supply, because otherwise it will disrupt an otherwise well-managed domestic money supply.

The end result of this is that there can only be a limited amount of foreign investment, and foreign investors will swap their deposit accounts for some of our (or Swiss) free (unlent) and limited-in-quantity deposit accounts.

The ability of foreign governments to build up foreign exchange reserves, meaning that they buy into our government bonds and other assets, will be limited in this way, and there will be no use for them as foreign currency reserves used to manage an exchange rate.

All currencies will float at or around the level needed to create a balance of trade.

Market forces that do the job

The overall result of all three initiatives will be that market forces do what they are supposed to do:

(i) Each economy can work and be managed independently of others as far as money supply and aggregate demand is concerned, at least domestically;

(ii) Any excess exports or imports will alter the value of the currency so as to limit the excesses and rebalance them, and there will be no interference in the domestic money supply from external investors;

(iii) The domestic money supply will be precisely controlled and

(iv) There will be no imbalances, increased debt, or trickle-down period after a stimulation has been made.

(v) There will not be a need to know exactly how much new money to create because if too much is created then all prices, incomes, wealth and so forth will inflate at about the same rate in a BALANCED (undisturbed) way (Mark I economic model), keeping employment and spending in balance and preserving all of the economic activity unchanged.

Finally, the main principle: market forces that determine who does what will be allowed to continue undistorted, whereas at present that does not and cannot happen.

If readers need more explanations, here is an index of past essays that explain how all of this can be made to work.

 - Fin24

* Edward Ingram has a strong and growing support base. One American has started a petition asking President Barack Obama and/or his senate committees to look into these ideas. Ingram says: “Why not here in South Africa? The ideas are universal.” 

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edward ingram  |  money  |  investments

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