Aurelio Ojeda
It is widely accepted by economists that the economy is not a science that can predict phenomena with some accuracy. This consensus motivated a known economist to say, some years ago, that the best professor of Economics is that one who can tell the story that “makes more sense”. What you will read in the following paragraphs will try to distance it self from that anecdotal Economics, which lack in measurements based in a system of money circulation.
It is impossible to explain how money can dissapear, if we do not know what is really money. How can money disappear just like that?, or take shape in so different things like one dollar bill, some amount of electrons, or electric charges in the computer of a bank? At a first look this seems to be incredible.
Money is only information that flows within the economic system, because it is specific for this system. The mathematical demonstration of this affirmation was presented by the author in the 31st Conference of The Academy of Economics and Finance, which was held in Jacksonville, USA in 2007. Any physical object acknowledged as money by society carry some amount of information per unit.
To understand this affirmation, without going through mathematical equations, we can consider the following example. If you go into some shoe store and you are interested in some specific pair of shoes, you will exchange the property of your money for the property of those shoes. After that the proprietary of the store will have interest to own a cellular phone, and in turn will cede the property of the money you gave him in exchange for that other object. If these transactions were paid using debit cards, nobody saw the money and only were given information that flown between stores and banks. In this example the information was carried by electrons within some electronic components.
How much money should circulate? This is something that the economic system determines in free market societies. The Government can only influence with interest rates or promising payment with money as we see nowadays. This is a provisional money creation, which money circulation of the markets must validate. During normal times, only private banking creates money using the so called fractional deposits: if you have unused money in the bank, they will lend that money without your express authorization, the borrower deposits this money, and so on, and your initial money amount is multiplying the total deposits in banks.
Let’s see know how to verify in an experiment the changes in money circulation generated by an accelerated fall in the credit markets. This experiment was conducted using the interconnected network of the aggregated markets of the USA economy, and economic data of the most important markets (total sales of merchandise and services, money markets and labor market).
The markets for high risk mortgages work without much public transparency. However, using data of the RealtyTrac U.S. Foreclosure Market Report, it is possible to calculate that the foreclosures of sub prime mortgages, at the average price per house, reached roughly 200 Billion dollars. To call this “high risk” mask to some extent the reality: there are also false and misleading information. The lack of information of honest buyers and sellers and deliberate misinformation explain these information errors (noise), but there is no data of how much was intentional or not.
If you still are not convinced of the decisive roll of moral patterns in business, keep reading please.
The lost of 200 B$$ in deposits of mortgage sales is multiplied 6.24 times (as per average of 2005), which means that these deposits have been generating 1,480 B$$ that disappeared as a consequence of the inverse effect of fractional deposits. This amount surpass the reported reduction of 1,080 B$$ in the flow of mortgage credits and to financial institutions in 2008 through June (Bureau of the Federal Reserve). We introduced this loss in the national network of money circulation of 2005 (last available) Without the use of any probabilistic parameter, it was possible to determine the following effects.
The system “burns” more than 1,000 B$$ when its property disappear (information). This reduction takes place at a fast pace because only one transaction amounts more than $200,000 in average. This has an immediate effect in the money markets for payments (higher money demand).
What we have discussed through this point is a story which could be very similar at what we usually hear in anecdotal Economics.
Even when money and physical circulation in the must important markets remain unchanged (international trade, domestic markets and labor market), the changes generate a sudden fall in the offer of all these markets.
This last event creates a reduction of sales in all aggregated markets, up to an immediate reduction of 0.9% of total annual money circulation. This amount match the reduction reported in October-November of 2008. for final product sales and labor market
If the errors in the perception of the real situation are not very widespread, in a period of 1 or 2 years a reduction of 50% in the aggregated offer will take place. This will duplicate aggregated demand (Demand = 1/ Offer).
The chain of events will lead us to duplicate the relationship between energy/money for the physical circulation of products in the system, which will turn in a 30% fall of the average sale price.
This process will then diminish 2.3% of money circulation, as well as a reduction of 4.7% (6.9Mill.) in the employed work force. The Bureau of Labor Statistics reports already a reduction of 3.1 Mill. between November of 2007 and 2008.
If a price reduction does not take place immediately, the system will lose inertia or momentum. With constant prices, this lose in the energy input into the system would increase to 3.4% the annual decrease of money circulation and diminish 7% the physical circulation of merchandise and services.
These values are not a forecast, but only the quantification of the inertial effect of the circulating money lost. If all necessary data of 2007 were available, the estimation of these amounts would be more precise.
However, using these numbers would make it possible, during the next 2 years, to evaluate the real evolution of the process of changes triggered by the money lost. Such changes could be higher or lower, as they could be influenced by the efficiency and ability to recuperate of millions of participants, as well as could be limited if government intervention introduces new unnecessary noise.
We must remember that the foreclosures merely reach 10% of the high risk mortgages (data of the Federal Reserve of New York). Also, the effect of the 60% reduction in oil price would compensate less than one third of the total reduction of sales prices.
With the magnitude of the changes described, a great volume of lower efficiency companies going out of business, and a profound technological restructuring are unavoidable. All these effects concentrate in banks because almost all money circulation takes place through them.
We are in an important crux, where also international economic relationships and new technologies will play a decisive roll. The secondary effect of the international network of money circulation is unknown, and require a similar approach to complete the analysis.
