“Davidson” submits:
Real Private GDP, currency creation, inflation, corporate profit are all intimately connected. There is no mathematical relationship, but they trend together.
Understanding economics, corporate finance, GDP, inflation are only connected through experiential observation. The failure of our efforts to apply math is based on the fact that every day, every year and every investment cycle occurs based on advancing our knowledge based on what we learned yesterday, last year and etc. Our thinking and action based on our accumulated knowledge never repeats. Today’s cycle includes the iPhone, introduced 2007, which we did not have the last cycle. Smartphones have drastically lowered cost of communication and information gathering, i.e. deflationary.
The way the iPhone came about and all its infrastructure was through corporations making a profit This is how Free Markets work. One has to get to the level of individual transactions and analyze what is going on between individuals to break down how today’s markets work and what they represent.
1) Millions of years ago markets evolved as the most efficient method of survival for groups of proto-humans. Individuals with specific talents, like arrow head making, made the best use of limited materials and time to make arrow heads for all. They traded these for those individuals who made the best foot ware with the least waste and so on for each survival need and skill of the group. They could not afford to waste resources or time letting the poorly skilled make useless tools for the rest of the group. Someone who insisted on making something the group did not need, made it poorly or wasted resources would quickly have found few willing to barter for other goods of survival. Individuals naturally migrated to doing what was best for group survival. Even back as far as 4mil years ago ‘faster, better, cheaper’ was required. Markets are ‘US’ and are simply more sophisticated today. Markets are so ubiquitous as an aspect of society operations that we fail to see them unless we step back and look carefully.
2) The goal of market behavior is survival and to advance our standard of living. Same as today.
3) Currency at some point was invented as a store of value to handle society’s variations in production. For example, those who made arrow heads for all, found that some could not pay via barter till a later time and a ‘chit’ was agreed upon as an I.O.U.. A value which could be redeemed at a later time. The greater the difference between the producer’s cost of production and the barter amount received could be thought of as ‘profit’.
4) ‘Profit’ also represents the excess value society was willing to pay for advancing its standard of living. ‘Profit’ is the measure of innovation/invention of something of value to society for some one who can lower the production cost below what society is willing to pay. The same is true today. If one cannot make a profit, then society is not willing to pay for it, does not see it as something of value in advancing the standard of living. The growth of GDP is in essence the profitable advancement of our standard of living. It must be profitable or else it cannot be done. This is the primary reason why Socialism fails. There is no basis for innovation and profit which is the driver of Free Markets.
5) ‘Currency’ expansion occurs in the process of lending one’s excess store of currency. Some one like an Apple, which has 25% Net Profit on its products, builds a net store of currency and decides to lend it to some one else to make money on lending money, i.e. Capital. Profitable businesses such as the Rothschild’s morphed into banks. Banks developed fractional lending using underwriting standards developed through experience. Today’s fractional lending lets us lend 9x the value of banking reserves. For every $90 lent we must have $10 in cash reserve. When banks lend, they create currency. If the venture is profitable, the loan is paid off, replaced with equity and in effect currency has been permanently added to the financial system. Should the venture fail, the loan defaults and the earlier currency issued is destroyed. In the US, our Real Private GDP growth is ~3% when all is said and done across economic cycle to cycle. Currency growth matches Real Private GDP + what is necessary in global trade now that other countries are issuing debt denominated in US$.
6) Inflation occurs when currency is issued by governments, little lasting benefit to society occurs and the failure of government policies does not result in default or currency reduction. The net/net effect is more currency without an increase in Real Private GDP. The expansion of non-productive currency issuance dilutes the value of all currency and we see inflation. War and ‘Great Society’ programs have been the most inflationary. How government spends discretionary money is the basis of inflation. Rarely do we have honest cost/benefit analysis much less measure it. Spending to benefit one’s own political base can be without competitive bidding and we have seen many historical examples of ‘cost over-runs’ or little of value received or benefit result. These are very inflationary.
The point of view I have spelled out cannot be measured mathematically but can be seen in our financial history. War is always inflationary as was the Great Society. That inflation does not arise from commodity prices or the acceleration in Money Supply is readily seen in the last 15yrs of data. Inflation does not arise from economic activity as only profitable businesses survive. That inflation has always occurred via government spending has a long, very long history back more than 2,000yrs. Venezuela is only the most recent example. Socialism or any other form of government other than Democracy typically runs inflationary monetary policies which cause them to eventually collapse as leaders seek to support themselves at the expense of citizens.
We have been trapped using math to seek answers in our economic behavior. Math provides misperception. We tend to trust math based on the results of science, but economics occur through human behavior/perception setting values to things which add to our standard of living which are different day to day. Math has no place as a tool.
Economics is not a science. Finance is not a science. Better to understand that good companies like Danaher reflect good human behavior. Good countries for business reflect the degree of Democracy that exists.