Debt and Production

I was arguing with a guy who insisted that money must have a time value (Link deleted - I'm trying to avoid having that blog owner having to deal with people who don't start to share his politics; apologies if that causes offense). My own education suggested to me that he was referring to concepts like the MARR (Minimum Acceptable Rate of Return), which is a corporate policy that evaluates the profitability of a project in terms of the time to achieve a future project, given inflation and a desired additional return, i.e. a profit. It turns out that he meant a desire to get a substantial amount of money up front for a purchase, e.g. a house loan. Oh well. It got me thinking about profitability (the argument was about debt, and the relative importance of debt vs theft of production in Marx's sense). I had a strong impression that profit-seeking would lead to inflation, and did some exercises in search of a model, to confirm this suspicion. The following conclusions and thought experiments are a result of those exercises.


Consider an economy which has only one production unit/company, that creates things-for-sale that maintain their value over time (i.e. one can sell an old one for the price of a new one). The company creates M items, of which it sells N, at a price of P per unit sold. Its expenses for materials, wages etc. are C. Thus its profit is PxN-C, and its return is R=(PxN-C)/C. Where does this profit come from? Possibilities include the workers' funds (from which they buy the units), money created by a bank or government, and a loan (possibly via a bank) that the owner/production unit makes to the workers to buy the product. To remain profitable, the company must make more than it pays - some portion of the sale can be made through the materials cost, which can be realized in this example as a wage paid to the extraction workers, to keep the production unit singular for simplicity sake, but some portion of the profit has to come from elsewhere. [Correction: 17 February 2010 The number of items represented by the money in existence increases, so this example is actually deflationary. To see the point I had in mind, let the products be destroyed, although that just jumps ahead a few steps.]

Once the company has sold enough units to deplete the workers' funds, it can either stop operating (at least at a profit) or it can continue operating by suffering inflation through the creation of money, or by issuing debt to the workers to buy more product - which will require inflation later, before they start paying the interest portion of the loan. By working to pay off the interest (no purchases), the workers don't solve the problem of the money distribution, because in that case, the business ceases to be profitable (no sales), and must cease to operate. This inflation is thus due to the distribution of money.

The situation does not change much with extra producers and their workers. At most, one producer can sell to another, and the workers of one producer can buy from the other producers. The net transfer of money between producers and workers is of determining importance. Let us partition the economy into three units: Profitable producers, non-profitable producers, and workers. Non-profitable producers may transfer a net amount to profitable producers and workers considered together. Their effect may be inflationary or deflationary, depending on how much they produce before going belly up, but if the economy is overall profitable, one again sits with this problem - workers must use their funds to buy product, or must get the funds from elsewhere. Slavery in a production sector does not solve this problem - money will have to be created to a greater extent to buy slave-produced goods, or the profits must be redistributed, to avoid the disappearance of the market arising out of lack of funds. (End of correction)

Now let us consider consumer goods. We destroy the market value of an item as we buy it (e.g. by eating it, opening the package etc.). By buying and using, we create an inflationary tendency (we destroy that which the existent money presents a claim on), and by producing, we create a deflationary tendency (by shaping that which the existent money presents a claim on). Consider when the production and consumption occur at the same rate (a stationary economy); we have the same problem, namely an accumulation of profit, which must come from somewhere. (Should the production unit continually reinvest its profits, inflation of this type might be avoided, otherwise there must be either an inflation, or a loss of general profitability - debt/loans only postpone the problem until the point when the cumulative payment on the debt including interest covers the profitability).

Now consider where an economy grows consistently, with some degree of net saving of profits, and thus has a money-induced inflation. Next a further saving/efficiency improvement/increased rate of return occurs. Now the production sector has a choice of how much of the saving to pass on to consumers/the market. If it collects the entire profit, there is necessarily further inflation as before, and if it is invested, there is the risk of inflation in one production unit, and deflation in another, as funds are transferred, but without the above money-induced net inflation. In practice, banks will borrow out their bank accounts to avoid this accumulation, with some money generation through debt (fractional reserve lending). In this way, the money distribution problem is solved by growing debt, with associated interest, as the bank is not in the first instance a consumer. The new problem is somewhat mitigated through the institution of bankruptcy.

Beyond the additional debt arising from accumulation in this scheme, there is a further problem that interest payments due to the additional debt reduce the demand in primarily worker-serving markets, and/or cause inflation as workers demand higher pay to make their interest payments.

North American comment: Notice that I've avoided the question of the material basis of the economy - other inflations, such as reduced energy content in a product at a given price etc. that are often hidden, have escaped consideration (notice how the cheese packages of a given presentation cross-sectional area get lighter with time at a constant price - packages that used to contain 1kg is down, depending on the brand, to 750g or 500g.)