The correlation between GDP, taxes, and debt.

This will be a lesson based on the Khan Academy economics course to explain how government tries to affect the economy. I say “try to,” because evidently government cannot fully control the economy as it might wish. This makes sense, when we want to compare government policies between, say Democrat vs. Republican leadership. There is no clearly defined border between the two. There is always a delay, number one, and number two: depending on the conditions (economic and otherwise) the implemented policies may or may not result in its intended purpose to the desired degree.

There are basically two kinds of policies: Monetary and Fiscal policy. Monetary policy deals with how much money to print by the “Central Bank”. In the USA that is a quasi independent institution. It is run by the government, but also gets input from private industry, such as banks. It is given the right to print money, but it is mostly electronic money. It buys “debt”. An interesting way of “lending money”. When someone buys bonds, he/she directly lends money to the government. This increases the amount of money.

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When the supply curve moves to the right, interest rate will drop, as seen in the graph by the little yellow line on the demand curve, while the supply of money increases as seen on the yellow line on the horizontal supply axis. This is like micro economics. When more money is available because of the shift in money demand, that shifts the aggregate demand on the macro economical side to the right, stimulating the economy, thus increasing GDP as can be seen in the graph below:

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This graph compares Price on the vertical axis to GDP on the horizontal axis. So, GDP can increase because more money is available.

Another way that aggregate supply can increase is through fiscal policy. Fiscal policy is the government directly demanding goods and services from the economy. It uses two sources to finance those demands: taxes and / or debt in the form of treasury bonds and other means. Say, the government issues more bonds, thus increasing the debt, but taxes remain the same. This will increase spending, having the same effect as the increase in money supply in the previous example.

This brings up an interesting difference between the Democrats and Republicans. Typically, but not always, the Republicans want to hold the line on taxes and at the same time not increase the debt. Democrats tend to want to increase social programs meaning increased taxes. The way I see it, is that the Republicans, for the most part, want to increase or stimulate the economy, at the appropriate time through printing more money (micro economics), while the Democrats want to stimulate more directly through tax increases (macro economics). Both parties want to promise the moon, so need more money to fulfill their promises, but since neither can get the full amount they want in their own way, debt on the fiscal side goes up, unchecked. I say “unchecked”, because debt keeps rising no matter which party is in the majority. That is just my simplistic opinion, looking at how our economy functions.

GDP and Luca Pacioli

In my last blog, I wrote that GDP ignored the difference between credits and debits, or assets vs. expenses. It only records “transactions”. In a prior blog I also referred to National Debt as a humongous concept and was wondering what we as “peons” can do about it. I think we can do something about it! We have to speak up against the “Enrons” of the world, who misrepresent the accounting principles. They should be forced to explain their accounting processes. Also banks often use very “loose” accounting practices to make their status look good; better than it really is. Paclioli addressed not only double entry accounting, but also the ethics of accounting. Alas, the ethics today are going by the wayside.

Thomas G Rooney: “Paclioli was a Catholic monk who observed local Italian parissoners often in need of a hand out, not able to keep track of their activites, so he came up with a kind of community outreach plan in the form of a work book to help people 500 years ago keep track of their transactions by type. Debitiere is what one was to do with where something was put, and creditiere was what one was to do in recording where something came from. But in the “Nobody is going to tell me what to do” society, people often do not want to be told to keep track of messy things like that, and just enjoy the fact that transactions are occurring.  Paclioli’s system spread far and wide, now used by just about every entity that exists to keep track of things…. banks, trust companies, realtors, insurers, the professions, businesses, many churches, etc. But for some reason, governments only like half the system, emphasizing trnasaction volume, happy with inflows, whether the source is income or debt….. happy with outflows whether the object is an asset or an expense … as long as there is movement, you got that right Bert.”

“Since Pacioli was a Franciscan friar, he might be referred to simply as Friar Luca. While Friar Luca is often called the “Father of Accounting,” he did not invent the system. Instead, he simply described a method used by merchants in Venice during the Italian Renaissance period. His system included most of the accounting cycle as we know it today. For example, he described the use journals and ledgers, and he warned that a person should not go to sleep at night until the debits equalled the credits! His ledger included assets (including receivables and inventories), liabilities, capital, income, and expense accounts. Friar Luca demonstrated year-end closing entries and proposed that a trial balance be used to prove a balanced ledger. Also, his treatise alludes to a wide range of topics from accounting ethics to cost accounting

Pacioli was about 49 years old in 1494 – just two years after Columbus discovered America – when he returned to Venice for the publication of his fifth book, Summa de Arithmetica, Geometria, Proportioni et Proportionalita (Everything About Arithmetic, Geometry and Proportion). It was written as a digest and guide to existing mathematical knowledge, and bookkeeping was only one of five topics covered. The Summa’s 36 short chapters on bookkeeping, entitled De Computis et Scripturis (Of Reckonings and Writings) were added “in order that the subjects of the most gracious Duke of Urbino may have complete instructions in the conduct of business,” and to “give the trader without delay information as to his assets and liabilities” (All quotes from the translation by J.B. Geijsbeek, Ancient Double Entry Bookkeeping: Lucas Pacioli’s Treatise, 1914).”

 

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Luca Pacioli: The Father of Accounting

GDP – The Nation’s Economic Hero

By the curious standard of the GDP, “the nation’s economic hero” is a terminal cancer patient who is going through a costly divorce. The happiest event is an earthquake or a hurricane. The most desirable habitat is a multibillion-dollar Superfund site. All these add to the GDP, because they cause money to change hands. It is as if a business kept a balance sheet by merely adding up all “transactions,” without distinguishing between income and expenses, or between assets and liabilities.

The strange fact that jumps out from Bennett’s grim inventory of crime, divorce, mass-media addiction, and the rest is that much of it actually adds to the GDP. Growth can be social decline by another name. Divorce, for example, adds a small fortune in lawyers’ bills, the need for second households, transportation and counseling for kids, and so on. Divorce lawyers alone take in probably several billion dollars a year, and possibly a good deal more. Divorce also provides a major boost for the real-estate industry. “Unfortunately, divorce is a big part of our business. It means one [home] to sell and sometimes two to buy,”a realtor in suburban Chicago told the Chicago Tribune. Similarly, crime has given rise to a burgeoning crime-prevention and security industry with revenues of more than $65 billion a year. The car-locking device called The Club adds some $100 million a year to the GDP all by itself, without counting knock-offs. Even a gruesome event like the Oklahoma City bombing becomes an economic uptick by the strange reckonings of the GDP. “Analysts expect the share prices [of firms making anti-crime equipment] to gain during the next several months,” The Wall Street Journal reported a short time after the bombing, “as safety concerns translate into more contracts.”   by:  Clifford Cobb, a policy analyst, is the author of Responsive Schools, Renewed Communities (1992).   Ted Halstead is the founder and executive director of Redefining Progress, a nonprofit public-policy organization in San Francisco.  Jonathan Rowe has been an editor at The Washington Monthly and a staff writer for The Christian Science Monitor.

That is the economy for us. Next time you read in the paper (or see a graph) how the GDP has increased, don’t get too enthusiastic too quickly. Consider why it increased. Is it an “asset” or a “liability”?  National Debt is seen, in part, in relationship to GDP. If GDP goes up, typically National Debt is allowed to move up as well.

US GDP growth rate

How can we influence national debt?

I missed two weeks of blogging, while on an RV trip to Long Beach and Yuma Arizona. During that time I was able to re-evaluate my goals using The 7 Habits of Highly Effective People.

Habit 1 is: to be pro-active. The problems, challenges, and opportunities fall into two circles, if you will: A circle of concern and a circle of influence. The circle of influence includes things like our health, children, problems at work. Those are what we can do something about. Other things we have very little control over, such as the weather, terrorism and the national debt. But National Debt is my topic!

Habit 2 is: “begin with the end in mind”. How do you envision the end? If I cannot influence the National Debt, then how do I envision the end? In my last blog, I challenged young people to look for options of paying for college. I envision the end as looking for ways to learn and share the mechanics of how National Debt works. In the process I find confidence and a sense of relaxation while the world is in turmoil. Learning about business cycles made me realize that I don’t have to become nervous when we get in a recession.

So, I may not be able to influence National Debt directly, nor do I envision the end of National Debt, but I can learn and share the mechanics of how National Debt works. I can envision that in the end my audience (you!) and I will understand it better and can explain how it fits in our society.

“Families have to pay back their debt. Governments don’t — all they need to do is ensure that debt grows more slowly than their tax base. The debt from World War II was never repaid; it just became increasingly irrelevant as the U.S. economy grew, and with it the income subject to taxation.

Second — and this is the point almost nobody seems to get — an over-borrowed family owes money to someone else; U.S. debt is, to a large extent, money we owe to ourselves.

This was clearly true of the debt incurred to win World War II. Taxpayers were on the hook for a debt that was significantly bigger, as a percentage of G.D.P., than debt today; but that debt was also owned by taxpayers, such as all the people who bought savings bonds. So the debt didn’t make postwar America poorer. In particular, the debt didn’t prevent the postwar generation from experiencing the biggest rise in incomes and living standards in our nation’s history.” (Nobody Understands Debt, Paul Krugman)

debt-as-percent-of-gdp

This graph shows how the National Debt was over 100% in the mid-forties as described by Paul Krugman.

So how do we get out of debt?  Should the USA do it again, as after WWII?