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Pitfalls in Economic Thinking

 

PITFALLS IN ECONOMIC THINKING

Maher D. Kababji

 

Published by Maher D. Kababji at Smachwords

Copyright 2017 Maher D. Kababji

 

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Shakespir Edition, License Notes

Thank you for downloading this free ebook. Although this is a free book, it remains the copy righted property of the author, and may not be reproduced, copied and distributed for commercial or non-commercial purposes. If you enjoyed this book, please encourage your friends to download their own copy at Shakespir.com, where they can also discover other works by this author. Thank you for your support.

 

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Table of Contents

 

Author’s Preface

Chapter 1: Economic Resources

Chapter 2: Economic Activities

Chapter 3: Market and Prices

Chapter 4: Exchange and Money

Chapter 5: Finance

Chapter 6: Foreign Currencies

Chapter 7: Redistribution of Wealth

Conclusion

 

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Abstract

 

One of the main functions of a government is to sustain all its population at or above the prosperity level which expresses the feasible material standard of living that an economy can provide. Governments failed to realize prosperity and financial distress is increasing. This book aims to discuss in simple wording each of the factors that causes the failure of the present economic systems to realize prosperity, highlight the pitfalls in economic thinking, and introduce an alternative fair economic system that would reflect fair economy and advance the needs of humanity as a whole.

 

 

 

Author’s Preface

 

 

Financial distress is increasing. Corruptions are going on around the world. Prices are soaring. Poor is becoming poorer. Living standard of middle class is declining. Relatively small number of individuals and corporations are controlling huge pools of capital. Public debt is increasing. Confidence in currencies is deteriorating. The bursting of several financial bubbles in last decades points to the fact that present economic systems have failed to achieve the economic goals.

 

The most dominant economic systems at present are capitalism and socialism. Some Islamic countries such as Iran practice what is so called Islamic economic system. In practice, they imitate traditional capitalistic measures under different names.

 

The socialist planned economies failed to realize its target of equality. Capitalism has been transformed into monopoly-finance capitalism leading capitalists to earn wealth through foul means.

 

In order that an organized body of knowledge might be classified as science, its hypothetical law must be based on facts. Unlike any other social science, fallacies are the root of the technique of thinking in economics. By the lapse of time, theses fallacies have been blindly accepted as if they represent a part of the natural life which people have to live with.

 

Economics is concerned with prosperity as the material aim that contributes to the nonmaterial ultimate objective of happiness. It studies the many activities undertaken in relation to wealth. Economic activities have their origin in the wants of a community. They take place in the framework of an economic system. Economic system organizes the ways by which a society utilizes available resources so as to produce and accumulate wealth and the ways by which wealth is exchanged and distributed.

 

Failure of present economic systems to realize prosperity makes it necessary to structure an alternative system that would reflect fair economy through reviewing, in simple wording, the foundations on which present systems are based.

 

 

 

Chapter: 1

Economic resources

 

 

An economic resource is any asset used to produce goods and services that meet human needs and wants. The economic resources include:

Natural resources

Natural resources are derived from the environment. Land, water, and air are ubiquitous resources. Minerals such as iron ore and copper are located beneath the earth. Forests, animals, birds, fish are obtained from the biosphere. Sunlight, air, and wind are available continuously. Unlike forests and fisheries, coal and petroleum cannot be replenished, once they are depleted.

Human resources

Human resources refer to the human mental and physical effort that is directed to the production of goods and services. Human resources can be defined in terms of skills, energy, talent, abilities, or knowledge.

 

Resources are selected and organized so as to produce goods and services. Production is meant the activities which result in the creation of goods and services. A mine excavates raw material, a factory transforms raw material into products, a labor provides physical or mental efforts, a retailer adds marketing services to products, and a doctor offers professional services.

 

Ownership Rights

Ownership is the right to the exclusive enjoyment of a thing including the right of using, altering, disposing of or destroying the thing owned.

 

Socialism denotes an economic system that is based on state ownership of natural resources as well as products. The money incentive is lost due to ignorance of the rights of private ownership. Mainly, the lack of motivation of profit is responsible for the failure of the socialist planned economies.

 

On the contrary, capitalism is an economic system which is characterized by private ownership of natural resources and products. In practice, capitalism leads to concentration of wealth in few hands, earning of wealth through foul means.

 

Natural resources are free gift. They have been bestowed to be exploited in favor of the society as a whole, and hence they should not be monopolized by any particular person or persons to the deprivation of others. Ownership rights should be fairly specified. A sound economic system should fairly distinguish between public property and private property.

 

Public property

Public property refers to the assets that owned by the state. Natural resources are public property. A government, being the custodian of the general interests of all members of the society, is responsible to put public properties to the best use. It has no right to privatize public properties. Mining, waterworks, communication, and energy works are examples of the activities related to exploitation of natural resources. Raw material is the output of exploitation of natural resources. A government sells raw material to private sectors for final consumption or in order to produce final products. The income accruing from selling raw material should be spent for the welfare of the society.

 

Private property

Private property refers to the assets that are owned by an individual or the private sector. An individual has the right to live and own his business. Private ownership should reflect the personal needs for living and business. An individual has the right to own buildings, land, furniture, machinery, and goods for his living or business. A government has no right to nationalize legal private property. The action of those who occupy or own a plot of land in different ways simply to earn money by selling to those who require it for agricultural or construction purposes should be stopped from doing that. There should be no place for the activities which have no effective role in production.

 

Factors of Production

Factors of production are the inputs that are used in the production of goods and services. These factors are generally classified by economists under four headings with special senses:

Land: The term includes all natural resources.

Labor: The term refers to physical or mental effort directed at production.

Capital: The term includes capital goods used in the production processes in addition to funds raised to operate and expand the business.

Entrepreneurship: The term refers to the function which includes organization, planning, management, and bearing of the investment risk.

 

Each factor of production receives a return, in the form of income, from its part in the production process. Rent is the reward for land. Wages are paid to labors. Payment for capital is known as interest. Profit is the return to the entrepreneur.

 

Money is not a factor of production. It is obvious that the terms used by economists to identify the factors of production have very specialized senses that do not correspond with ordinary usage in other social sciences. The highly specialized vocabulary is at the root of many economic fallacies. Except for bearing of the investment risk, entrepreneurship is merely a particular type of work, and should be included under the heading of labor. Money is not an input that is used in the production process. It is a medium of exchange. It has to be transformed into material or labor. Interest is the return to lending money. The production process is terminated by the liquidation of assets.

 

Natural and human resources represent the primitive productive factors. Not all natural resources can be utilized for production and not all human resources can be directed at production. Only labor force out of human resources may be employed for production. Out of natural resources, only discovered, dominated, and extracted materials may be exploited in production. The production process requires the combination of labor and materials. The combination cannot be achieved unless an investor is willing to bear investment risk. Accordingly, the factors of production and its returns may be classified as follows:

Material: Material includes discovered and dominated natural resources such as energy, seeds, and raw metals. Cost of material is paid to suppliers and charged to consumers. In some cases such as mining, cost of material equals zero.

Capital goods: Capital goods refer to the man-made resources such as machinery, roads, equipments, buildings. Rent or depreciation is the reward to capital.

Labor: Labor refers to all types of physical and mental efforts directed at production. It includes planning, management, and decision-making. Wages are paid to labors.

Investment risk: Investment risk is an intangible asset which causes hardship for the investor. Profit is the return to the entrepreneur for bearing of the investment risk. In the absence of profit, there will be no incentive for investors to take investment risk.

 

Scarcity of resources

Economists believe that scarcity of resources restricts output growth because wants are innumerable but the resources for satisfying those wants are limited.

 

The excess of the world output growth over the growth of the world population emphasizes the abundance of natural resources on the global level. Global indicators shows the world output growth in comparison to the world population growth for the years 2010, 2011, 2012, 2013, 2014, and 2015. While the growth rates of the world population, as reported by UN, Dept. of Economic and social Affairs, were 1.18%, 1.17%, 1.16%, 1.14%, 1.12%, 1.09% respectively, the growth rates of world gross world product, as reported by International monetary Fund, were 5.4%, 4.2%, 3.4%, 3.4%, 3.4%, 3.5% respectively.

 

On the national level, there are marked differences in resource distribution between regions or countries. The collection of available resources may differ from the resources needed for satisfying the requirements of the community. International trade allows the exchange of natural resources and products. Job vacancies and skills requirements can be filled through immigration.

 

Scarcity of resources is uncertain. Depletion of some natural resources is a fact and discovery of new substitutes is also a fact. Coal energy was replaced by oil energy and solar energy is considered to substitute oil energy. The global supply of most commodities has grown dramatically since the end of World War II. No one can predict the future.

 

Historically, concerns about future resources were the main factor in many wars. The possibility of scarcity of vital natural resources in the future leads to anxiety, hostility, social unrest, geopolitical friction, and war. Material interests prevail over human rights and social values. Some countries dominate resources of other countries and encourage wars in order to reduce global population.

 

Governments should stop corruption and mischief on earth in order to eliminate the possibility of scarcity. A country should exploit its resources moderately and carefully to meet its present requirement without environmental degradation and without compromising the ability of future generations to meet their own needs.

 

Management of resources

A society must be able to produce minimum amount of all goods required to sustain all its population at or above a specified material standard of living. It can only achieve this goal if its economic possibilities encompass provision of the required bill of goods and services. Economic possibilities of an economy are the assets which an economy may have available to supply and produce goods and services. They include the available collection of natural resources, human resources, capital goods, skills, and knowledge.

 

A society may fail to produce even what would be possible with its existing resources. Natural resources may be under-utilized because of the lack of technology to discover or extract resources. Resources maybe inefficiently employed because of the lack of skilled labors or technical knowledge. The stock of natural resources maybe depleted because of the over-utilization of resources.

 

A society may succeed to attain even higher level of growth required for realization of prosperity, but the collection of the national output may differ from the collection that satisfies the requirements of the society. More resources maybe devoted to produce goods of higher profits such as weapons, capital goods such as machineries, or luxury goods such as pyramids and fancy squares.

 

Resources should be managed appropriately. It is the responsibility of the decision makers to set proper product mix, raise efficiency through education and training, utilize resources moderately, and encourage local production in order to reduce unemployment rate and reach higher level of output growth.

 

Improper management of resources is the direct result of the lack of qualified decision makers who care about public interest. In most cases, loyalty of a decision maker is directed to serve those who appointed him, the political party that supports him, or the financier of his election campaign. An economy may be controlled by those who have special interests such as, creditors, capitalists, financial institutions, and industrial or social lobbies.

 

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Chapter: 2

Economic Activities

 

 

Economic activities refer to the activities that produce earned income. Before establishment of banks, financial institutions, and financial markets, economic activities were limited to productive activities. In present economies, financial activities constitute an integral part of economic activities.

 

Productive activities

Productive activities refer to the activities that add value to national output. They satisfy economic goals. They include planting, mining, providing services, transformation of raw material into products, adding value to available products, and moving products to a different time or place. Products take the form of goods, services, or assets.

 

Production is a process of converting inputs into outputs. A mine excavates raw material, a factory transforms raw material into products, a labor provides physical or mental efforts, a retailer adds marketing services to products, and a doctor offers professional services.

 

Products are the output of the process of production. They include consumers’ goods for immediate and final consumption such as food and clothes, and capital goods for gradual consumption such as buildings, machinery, railways, and roads. Capital goods are used in further production.

 

Financial activities

Financial activities satisfy inflationary goals. Money is used to generate profits without being involved in productive activities. Even though economists share the same belief that the growth rate of national output is the indicator of how healthy is the economy, present economies are characterized by progressive shift from productive activities to financial activities. Development of worldwide link between financial markets in response to globalization increases the volume of financial activities.

 

Seeking for easy and quick profit with relatively low risk expedite the transformation into financial economy. Financial activities do not add value to national output. They produce inflation. They include Interest-based lending, speculative activities, financial corruption, taxation, and inflationary profits.

 

Interest-based lending

Interest is the return for lending or providing credits. Banks, financial institutions and financial markets are responsible for the excessive expansion of credits. They introduce great number of financing and refinancing tools:

Financial instruments such as loan and line of credit are used to finance projects and businesses. Marginal credit is used to finance speculators. Bonds are issued to finance big corporations. Treasury bills and governmental bills are issued to finance public expenditures.

Refinancing instruments such as discounting of commercial bills and mortgage securities help banks to liquidate their credits in order to expand more credits.

 

Banks increase their deposits, credits and profits through calculating interest on a compound base. Also, the banking system practices what is so called “Money Creation Process”. The process enables banks to provide more credits, raise more funds in form of deposits, and increase their profits.

Assume that a central bank sets the obligatory reserve to be retained by banks to be 10% of deposits. This allows banks to loan 90% of total deposits. Suppose someone deposits $1000 in high-powered cash money, the bank can lend $900. Assuming that the seller from whom the borrower bought the merchandise re-deposits the $900 into a bank, this raises total deposits in the banking system to $1900 and additional $810 can be loaned out by banks. The bank can continue retaining 10% of total deposits in reserves form and loaning the rest of it. This process can continue until total deposits equal $10000, and total credits become $9000.

Money creation process explains why banks represent the wealthiest economic sector. Assume 5% is the interest rate on deposits, and 8% is the interest rate on credits, the banking sector will pay $500 to depositors and gain $720 from borrowers. Profits of the banking sector increase from $22 up to $220 as result of receiving a deposit of just $1000 in high-powered cash money. ($720 - $500) - ($72 - $50).

However, three conditions must hold for banks to turn $1000 of high-powered money into a money supply of $10000. First, money must be circulated into the banking system. Second, banks must lend 90% of deposits. Third, borrowers must be willing to borrow whatever amount the banks want to lend. In practice, these conditions are partially met.

 

Interest-based lending is presented as a process of money injection which is necessary to finance productive activities. But, in return for its financing role, interest-based lending inflicts greatest harm to the society because of its inflationary role:

Interests paid by sellers are added to the cost of goods causing increase in prices.

Interests are added to public debt. In his article “The biggest financial crime in the history of the United States” addressed to the US citizen via Internet, Dr. Don J. Grundmann, D.C., M.H. says: “Since in 1996 approximately 40% of the United States budget went to the payment of interest on the national debt”.

Interest-based lending helps growing government spending and financial corruption. World Bank report “The Many Faces of Corruption” underlines, “the nature and quality of a country’s PFM (Public Financial Management) system to a large extent determine the ease with which public corruption can occur”.

 

Speculative activities

Speculation refers to the trade (buying, holding, and selling) of assets in attempt to profit from fluctuations in its price irrespective of its underlying value. Speculators pay little regard to the real value of the assets; instead they focus purely on price movements. Speculation differs from investment. Investment refers to buying of assets in order to profit from its use or from its income. The difference in the degree of risk separates the act of speculation from investing as well as from gambling. Speculative activities are very unstable. Reliance on speculative activities as a source of liquidity can cause a breakdown of the market economy. Soviet economy had a period of hyperinflation from 1921 to 1924 due to the sudden removal of speculative capital.

 

Spot exchange rates in foreign exchange markets are mainly determined by the international banks that are called the “Market Makers” in light of economical fundamentals. Forward deals reflect inequality of demand and supply on a certain currency and result in overbought or oversold risky positions. In 1992, currency speculation forced the central bank of Sweden to raise interest rates for a few days to 500% per annum, and later to devalue the Swedish currency.

 

Stocks are traded in stock markets. Prices of stocks do not reflect the fair value disclosed in the financial reports of the issuers. Fluctuations in prices of stocks are subject to number of factors such as historical data of price movement, economical conditions, and political stability. Stock speculators often take higher risk by entering long or short positions.

 

Lending securities, interbank transfers, treasury bills and corporate bonds are traded in money markets. Speculative tools such as derivatives and options are traded in financial markets. In case of instable financial markets, speculators invest in real assets, mainly real estate.

 

Commodity futures contracts are traded in commodities markets. The trading process reflects the volume of demand and supply on the contracts. It does not reflect the real demand and supply on the underlying commodity. While speculators gain profits from the air, buyers of the real goods pay higher prices in exchange for the commodities.

 

Some schools of thought argue that speculative activities create an efficient market by enlarging the number of competitors in the market. But the fact is that speculative prices, in most cases, reflect interests of large capitalists and giant speculators who dominate the markets.

 

It is true that speculative activities provide liquidity to market economy. But they have detrimental impacts on society because of its inflationary role. Speculative activities in commodities markets are behind the very rapid increase in prices of oil in previous years and in prices of gold and some foods in recent years. Speculation causes prices of underlying products to deviate from their intrinsic value. Dramatic rise in prices causes economic bubble and significant fall in prices leads to crashes.

 

Financial corruption

In general, corruption refers to wrongdoings in order to realize private interest at the expense of others. Corruption in public and private sector takes many forms such as bribery, embezzlement, robbery, deceiving, monopoly, greed, and misuse of authority.

 

Personal illegal behaviors are normally regarded as the main cause of corruption. Present living systems legalize illegal acts. Democracy allows a tiny group of people to direct political, economic and social policies in their favors through their participation in the ruling system or by supporting the election campaigns of candidates. Lack of transparency and effective controls encourage corruption. Economic policies, in many cases, take private interest, rather than public interest, into consideration.

 

Corruption plays an inflationary role. Consumers pay the cost of corruption in form of increase in prices or a fall in quality of goods and services relatively to prices.

 

Taxation

A tax is a compulsory transfer of resources from the private to the public sector. Governments use different kinds of taxes and vary the tax rates. In fact, consumers are the real payer of taxes:

Consumers pay all taxes levied on business owners. Business owners care about their net after-tax profit. Taxes paid by business owners such as production tax, customs duty, license fees, taxes on rent, stamps, fees on commercial transactions, and their social security contributions, in addition to taxes paid by business owners on behalf of their employees and labors such as pay-roll tax and labors’ social security contributions are included directly in the cost of goods and services and finally charged to consumers. Over and above, business owners increase their rate of profit in order to cover whatever levied on them as business or corporate income tax.

Consumers pay after-sale taxes. After-sale taxes such as value added tax, sales tax, and consumption tax represent additional price increase collected directly from consumers.

Consumers pay the hidden inflation tax. A government may issue money in order to pay interest on public debt, or cover cost of corruption, or support financial corporations in case of crises. This action produces what is so called hidden inflation tax. Hidden inflation tax causes reduction in the purchasing power of the currency unit. It represents an additional financial burden levied upon consumers since the fall in the purchasing power of the currency unit is translated into an equal rise in the general level of prices.

 

Most economists and politicians believe that present taxes are necessary as a source of fund to cover public expenditure, and that taxes help fair redistribution of wealth since rich pay most of taxes.

 

Business owners do not pay taxes. They charge consumers for their payments of taxes. Labors pay their taxes twice. On the one hand, their payments of the pay-roll tax and social security contributions reduce labor’s disposable income. On the other hand, the same payments are included in the selling prices paid by them as consumers.

 

In reality, present taxation system causes inflation. Cost of public services increases. Taxes reduce the disposable income of labors and those of fixed income, while owners of businesses gain more profits to keep up with their target profit margin and rich generate profits out of the appreciation of their assets.

 

Walter E. Williams, professor of economics at George Mason University, stated “Government income redistribution programs produce the same result as theft. In fact, that’s what a thief does; he redistributes income. The difference between government and thievery is mostly a matter of legality”. Libertarian opponents of taxation claim that governmental protection might be replaced by market alternatives.

 

Inflationary profit

Sellers care about their net profit. They do their best to obtain from consumers at least a certain average rate of gross profit on their sales. Assume a seller sets a profit rate of 20% on a jacket. If the cost of the jacket is $100, the selling price will be $120. He will make profit of $20.

If the cost of the jacket becomes $150 because of inflation, the selling price will be $180. He will make profit of $30 on the same shirt. The excess profit of $10 is inflationary profit. It goes without any additional expenses. The higher inflation is the higher seller’s profit.

 

Economists urge that financial activities are unavoidable because they are necessary to raise funds required for output growth. But; financial activities produce inflation which restricts output growth.

 

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Chapter: 3

Market and Prices

 

 

Selling is the final stage of any productive activity. It is the process of handing over one or more of the seller’s property rights through cash sale, credit sale, or rental sale, or by giving right to use in return for rent, toll, service fee, or by any other legal way of alienation. Price is the amount of money given in payment for the sold thing. Wage is the price for the sale of physical or mental efforts. Products are priced in term of money.

 

Markets

A market refers to the system which facilitates the exchange of products and provides the appropriate conditions within which appropriate prices may be fixed. Normally, prices are determined by the market forces of demand and supply. The influence of the market forces varies according to the time period involved, the physical location of the market, the nature of the commodity, and the numbers of potential buyers and sellers.

 

Demand refers to the quantity of a product asked to be bought at a particular price. The lower the price of a product, the greater will be the quantity demanded. Supply refers to the quantity of a product offered for sale at a particular price. The higher the price of a product, the greater will be the quantity supplied.

 

Natural market system refers to the ability of the market to correct itself with no external intervention. It provides appropriate conditions within which appropriate prices and terms are determined by mutual consent of related parties as a result of free interaction of demand and supply. Demand and supply fluctuate, but reach a temporary balance at an appropriate market price.

 

Natural market is an absolutely free market with free and clean competition. A natural rise in prices may occur as a result of an increase in cost of material, wages paid to labors, supplier’s profit margin, or volume of demand relatively to the volume of supply. The natural rise in the price of a product reflects an increase in its real value. The additional storage cost of summer plants justifies the increase in its real value in winter. The rise in the price of steel, because of the shortage of supply, reflects an increase in the real value of steel. Freedom of the market ensures determination of fair prices of products, fair wages for labors, and stability of the general level of prices.

 

Natural increase in prices of some products is not inflation. It has no impact on the general level of prices:

Natural free interaction of demand and supply returns the market price to an equilibrium point, since high prices encourage investors to increase supply and low prices encourage consumers to increase demand.

Variety of products makes the fall in prices of some products offsets the increase in prices of some other products.

Mass production, new discoveries, and technological developments help price reduction because they provide competitive products, cheaper substitutes, and economical methods of production.

Competition helps price reduction. In order to avoid greed, public commercial entities can be established to activate free and clean competition.

 

Adam Smith, in his book “The Wealth of Nation” (1776) refers to the natural market system as “invisible hand”. He explains the mechanism of demand and supply to control reasonability of prices set by sellers in environment of free competition. Smith said, “If a product shortage were to occur, that product’s price in the market would rise, creating incentive for its production and a reduction in its consumption, eventually curing the shortage. The increased competition among manufacturers and increased supply would also lower the price of the product to its production cost plus a small profit, the “natural price”. Smith believed that while human motives are ultimately out of self interest, the net effect in the free market would tend to benefit society as a whole”.

 

In present economies, markets are not free. Prices do not reflect what products are fairly worth. In socialist countries, economic activity and production are adjusted by the State to meet human needs and prices are fixed. In capitalist countries, different impediments limit market freedom. A government applies some policies to control prices, force minimum wage, and impose taxes. It may allow monopolistic acts by one supplier, more than one supplier, or an organization forming a cartel, trust, or pool. Some techniques, such as advertising, seek to alter consumer preferences and affect demand. Prices are soaring because of inflation.

 

Inflation

Inflation is defined as a rise in the general level of prices of goods and services. Keynesians believe that inflation is a pricing phenomenon. They propose that inflation is the result of pressures in the economy; an increase in aggregate demand, a drop in aggregate supply, or a rise in labor cost. From the viewpoint of the Monetarists, inflation is regarded as erosion in the purchasing power of money. They assert that inflation has always been a monetary phenomenon. When the price level rises, each unit of currency buys fewer products.

 

If money is used as just a medium of exchange for products, quantity of money in circulation will be equal to the quantity of money needed for the exchange transactions. Also, national income, which is the total sum of money received by all members of the society within a certain period, will be equal to the exchange transactions, which is the total sum of money received in exchange for goods and services within that period.

 

In addition to the exchange transactions, national income includes money received as return to the inflationary financial activities. More money is injected into the system in order to pay for interests, speculative earnings, ill-gotten gains, and taxes. The excess of quantity of money in circulation over the quantity of money needed for the exchange transactions reflects an increase in money supply over money demand. The excess of money supply produces inflation since the purchasing power of money declines. Inflation is a monetary phenomenon. It is the result of an excess of money supply.

 

Unlike the natural increase in prices that reflects an increase in the real value of products, inflation is an increase in the general level of prices. Inflation is a human-made phenomenon. It is the root of all evil:

Inflation represents the main cause of concentration of wealth. Poor becomes poorer. Living standard of middle class declines. Those living on fixed incomes suffer a severe decline in their living standard. Living standard of rich rises. Rich generate profits from appreciation of their assets. Business owners stand to gain from increased profits.

Inflation is a factor in social and political instability. Alcoholism, families breaking up, increased criminal rate, public demonstrations, and revolutions represent additional costs of concentration of wealth.

Inflation causes economic instability. Prices soar. Workers have less money to consume. Demand falls because each monetary unit buys fewer goods and services. Exports become more expensive to sell. Imports increase because they are relatively cheaper than locally produced products. Middle class savings are discouraged because consumers have to spend more. Pressure for increased wages mounts to keep up with consumer prices. Unemployment rate rises as a result of the decline in the rate of output growth

Inflation is responsible for the deterioration of the confidence in the currency. The purchasing power of the domestic monetary unit declines relatively to the purchasing power of foreign currencies.

Inflation makes money of innocent people to be at risk. Most of money invested in financial markets is borrowed money or money of others than the owners of the businesses. Banks and financial institutions borrow money from depositors. They lend depositors’ money to investors and speculators. Most of payments made by people to social security, retirement entities, and insurance companies are deposited in banks or invested in speculative activities and financial markets. Protection of the money of innocent people is introduced to justify supporting the financial system in case of crisis, but the process involves social oppression as governments use money owned by innocent people to reward financial institutions for their reckless excessive expansion of credits.

Inflation is responsible for financial crises. The excessive expansion of credits is the main cause of Wall Street Crash of 1929, the 2008 US Mortgage Crisis, the 1997 Asian Financial Crisis, 1998 Russian Financial Crisis, and the Latin American Debt Crisis.

Inflation rate may rise at very high levels leading to monetary collapse. High rate of inflation may lead to hyperinflation, stagflation, recession, high unemployment rate, currency devaluation and even total monetary collapse.

 

In spite of the ghastly impacts of inflation, economists recommend living with moderate inflation. They claim that inflation provides an incentive for investment as long as prices are rising and are expected to continue rising. They urge that inflation is unavoidable phenomenon because the inflationary financial transactions are necessary for raising funds required for the national output growth.

 

It is pitfalls in economic thinking. Present economies are inflationary economies. Inflation restricts national output growth. Inflationary financial activities encourage saving, while spending and consumption raises the rate of national output growth. Money is needed for the exchange of goods and services. There are no restrictions on the government to print as much money as needed for the exchange of goods and services.

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Chapter: 4

Exchange and Money

 

 

In early forms of society goods were exchanged by a process of swapping known as barter. An axe was bartered for a hen, or eggs were bartered for wheat. The difficulty of subdivision of goods used in barter and the dependency on a double coincidence of wants gave rise to the need for a common denominator to facilitate the process of exchanging products and evaluate products to be exchanged. Many commodities such as shells and stones were used as a medium of exchange. In ancient and medieval nations, states, as controller of the mint, made pieces of ingots out from metal, such as gold or silver.

 

The gold specie standard arose out of the need of a universal currency to be used in international trade. It is a system in which the monetary unit is associated with circulating gold coins of certain specifications, or monetary units made from other metal stated in terms of gold. The currency unit derives its value from the specie out of which it is made, and the rate of exchange of the currency unit for a foreign currency unit reflects the comparative worth of the specie out of which each currency is made.

 

Because commodity money is inconvenient to store and transport, it gave way to representative paper money backed, directly or indirectly, by gold or other species. Under the gold standard, domestic currencies were tied to the US dollar which was convertible into gold at the rate of $35 per ounce. People were exchanging their valued products for valued money.

 

The gold standard collapsed. In 1971, the U.S. President Nixon ends dollar’s link to gold established under Bretton Woods Agreement, thereby ending conversion of foreign officially held dollars into gold. Nearly all nations had switched to full fiat money which is state-issued money made of material of negligible cost in form of paper and coins.

 

Because people do not accept exchange of their valued products for valueless paper and coins, fiat money is declared by governments as legal tender to be accepted by law for the exchange of goods and services and settlement of debts. On the one hand, the legal warranty is necessary to ensure public acceptability of money and to provide confidence in currency units. On the other hand, the stock of goods and services available in the community represents the real currency backing.

 

Value of money

The word “value” literally means the material worth or the usefulness worth that something is held. The material worth of present money is zero since it is made of material of negligible cost. The usefulness worth of present money is zero since no one can benefit from money before being exchanged for valued goods or services. Present fiat money is valueless.

 

Present fiat money has purchasing power because it is declared by governments as legal tender and it is backed by the stock of goods and services available in the community. The purchasing power of money is the amount of goods or services that one unit of money can buy. Commodities have value and present money has purchasing power.

 

Currency backing

Currency backing is a historical tradition since the barter system had been transformed into the gold bullion system and at later stage to the gold standard where paper money was convertible into real gold. Countries had switched to full fiat money, but still retain currency backing in form of gold, precious metals, and foreign currencies.

 

In his book “Modern Economics – Principles and Policy, Kelvin Lancaster of Colombia University says “Currency backing is inherently ridiculous and based on public lack of comprehension about the nature of money”.

 

Getting rid of the currency backing is justifiable:

State-issued money is backed by the national stock of goods and services. Retaining currency backing in form of gold and foreign currencies involves unnecessary hoarding of resources that can be used for development.

Banking deposits, which constitute most of money in circulation worldwide, are not backed. According to the Federal Reserve Statistical Release of 02/14/2004, Issued money in USA as at January, 2007 was 750.5 billion dollars, while commercial bank money (in M2) was 6.33 trillion dollars.

Since President Richard Nixon declared the end of direct convertibility of the dollar to gold, the biggest economy in the world becomes not liable to retain currency backing.

Currency backing has no effect on prices of exports. If the price of oil in the international market is stated to be $70 per barrel, this price will apply for exports of oil irrespective the domestic currency of the exporter.

 

Raising funds

Money in circulation consists of state-issued money and banking deposits. Banking deposits are borrowed money. Most of funds are raised through borrowing.

 

Normally, central banks print money within limits mainly based on the rate of the national output growth. But, governments need more money to finance its growing expenditure. It has to pay due debts, interest on public debts, cost of corruption, and returns to inflationary financial transactions.

 

In addition to the state-issued money, governments raise funds through selling government bills, or borrowing money from rich countries or giant lenders. Public debt is growing rapidly. More taxes are levied to pay interest on public debts.

 

As alternatives to borrowing, a country may seek foreign investments, ask rich countries for grants, or apply spending-cut policies. Borrowing, grants, and foreign investments normally have severe impacts on sovereignty of poor countries. Spending cut policies reduce the rate of output growth and increase the unemployment rate.

 

State-issued money is deposited into the banking system. Banks use public and private deposits to grant credits. Business entities, speculators, and individuals borrow money from banks and financial institutions.

 

Public and private corporations including banks borrow money through financial markets. Financial markets introduce financing instruments such as treasury bills and corporate bonds, as well as refinancing products such as mortgage securities.

 

Activities of banks, financial institutions, and financial markets are encouraged in order to attract savings as the main source of funds. Saving is income not spent to buy goods and services. However, if savings are not deposited into a financial intermediary, there is no chance to be recycled as investment by business. Savings maybe stashed in or under mattress or invested abroad. Those savings may cause a recession rather than economic growth.

 

Functions of money

Traditionally, money was invented to be used as a stable medium of exchange. Present money becomes inflationary medium of exchange.

 

Money becomes an inflationary tool

Injecting more money than the quantity needed for the exchange of goods and services reduces the purchasing power of money, hence produce inflation. Because of the inflation, the purchasing power of the currency unit is unstable.

 

Having into consideration that the velocity of money is the number of times one unit of money is spent to buy goods and services per unit of time, and

Purchasing power = Exchange Transactions / Money in circulation

Assume that velocity of money = 20 times, and $40 billion of goods and services are exchanged. If $2 billion is in circulation, the purchasing power of money = 20 worth of goods. But; If $4 billion is in circulation, the purchasing power of money = 10 worth of goods. The decline in the purchasing power of money will be translated into an equal increase in the general level of prices. The selling price of the exchanged goods and services will be $80 billion.

 

Money loses its reliability as a measure of value

The process of exchange requires that money should firstly act as a measure of value. According to the general characteristics of measurement and evaluation, values are compared with certain standard unit. A certain length of a road may not be measured as 10 kilometers in a certain moment and as 11 kilometers in another moment without changes in the length of the road. Similarly, a ton of cement may not be valued at $40 in a certain moment and at $45 in another moment without changes the market conditions.

 

Present money does not represent standard unit. It loses its reliability as a measure of value. At the date of exchange, the value of a product is given in term of currency units of certain purchasing power. At later date of exchange, the value of the same product is given in term of currency units of different purchasing power.

 

Money loses its honesty as a store of value

Because the purchasing power of the currency unit is unstable, money cannot protect the right of its holder to obtain products of value equals the value of the products he might acquire when he received the money.

 

Money does not act as standard for deferred payments

Money measures the value of the debt in term of currency units of certain purchasing power. At the settlement date, the value of the debt is measured in term of currency units of different purchasing power. Due to the fluctuations in the purchasing power of money, money cannot protect the right of the creditor to receive the amount of the debt with money of the same purchasing power that was at the date he lent the money.

 

Monetary policy

The primary target of a sound macroeconomic policy is stated to be reaching the optimal level of output growth without inflation. Since output growth and inflation are conflicting, the only choice is between more or less growths coupled with more or less inflation.

 

Present monetary policy is directed toward controlling quantity of money in order to prevent the probable detrimental impacts of inflation. Monetary authorities apply monetary controls over interest rate, bank discount rate, expansion of credits, and currency exchange. Governments employ fiscal controls over prices, wages, government expenditure, and taxes.

 

The common effect of all these remedy tools is that they control, directly or indirectly, the expansion of credit. Credit squeezes may discourage investment in financial economy, but it causes economic slump, reduces national product, and raises unemployment rate. Expansion of credit may stimulate investment in financial economy, but it has bad impact on productive economy because it raises the inflation rate and develops destructive inflation’s consequences. Monetary authority tries to balance between positive and negative results of the controlling process, but in all cases they cannot prevent the economic instability. Markets may not respond in the way expected by the authority.

 

As a result of globalization and technological developments, financial markets, money markets, stock markets, and commodities markets all over the world are, directly or indirectly, linked together. Globalization raises the issue of the impact of economic performance of other country on domestic economy and the need to avoid such country risk. As the largest economy in the world, U.S. currency dominates international markets and trade. The 2008 U.S. financial crisis badly affects almost all countries worldwide. Country risk is taken because of retaining the U.S. currency.

 

A failed monetary policy can have significant detrimental effects on the society. These include hyperinflation, stagflation, recession, high unemployment, shortages of imported goods, inability to export goods, and even total monetary collapse. The use of public funds to support financial institutions and speculators is a sort of social oppression because people have to settle the public debts via increased taxes.

 

In order to realize prosperity a society has to reach the optimal level of output growth that satisfies the economic requirements of the community and maintains full employment. Reaching the optimal level of output growth requires getting rid of inflation.

 

Presentation of an alternative monetary system

A sound national monetary system has three main objectives:

To provide funds required for the exchange of goods and services.

To ensure stability of the purchasing power of the currency unit.

To combat financial corruption.

 

If money supply is growing at the same rapid that is justified by the payments in exchange of goods and services, funds can be freely raised, without causing inflation and with no need to borrow money, retain currency reserve, ask for foreign grants, or seek private investments. The stock of goods and services is the real currency backing.

 

Instead of directing the national monetary policy toward controlling quantity of money in order to limit the growth of inflation, the national monetary policy should be directed toward controlling movement of money in order to limit the growth of money supply to the growth of the payments required for exchange of goods and services.

 

Looseness of present monetary system does not help controlling movement of money. Funds are raised by the monetary authority and all banks. Money is available in form of banknotes, coins and banking deposits. It circulates in hands of individuals, public entities, private entities, and the government agencies. Part of money is hoarded or saved, and another part is invested abroad.

 

Effective control of movement of money requires that funds are to be exclusively provided by and circulated within a governmental monetary authority or central bank.

 

From the legal point of view, a government is responsible to stabilize the purchasing power of the monetary unit in order to protect the rights of the money holders. Setting money under control of the government is justified because money is declared as legal tender and when it is not in use, it represents legal right guaranteed by the government. Money cannot be claimed as private property.

 

In practice, the effective control of movement of money requires changing the functions of the central bank (CB):

CB does not issue money. Instead, it provides all banking services.

Cash money in local currency is recalled for cancellation.

Banking deposits in local currency are transferred to CB. Accounts of banks with CB are charged for the amount of transfers. The debit balance will be settled by the proceeds from liquidating the banking credits.

Cash money and banking deposits in local currency are retained by CB in unrestricted interest-free current accounts in the name of the money owners. Since each account provides a complete record of receipts and payments of the account holder, the records will help combating financial corruption including illegal operations, tax evasion and procrastination in paying debts by a wealthy man.

All payments are made by transfers between the accounts retained by CB.

CB issues prepaid smart cards to be used by consumers for paying sundry expenses.

CB issues Interest-free credit cards to consumers in order to encourage consumption.

CB grants temporary interest-free lines of credit to the governmental treasury in order to cover the deficit in the cash flows. The credit ceiling is set by the government.

CB, under its supervision and control, finances private and public productive entities through banks. CB retains a separate account for each financing deal. Profits of the central bank add a new source of government revenue.

Banking deposits in foreign currencies are transferred to CB and retained in accounts in the name of the money owners.

 

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Chapter: 5

Finance

 

 

Finance is the task of providing funds. Nobody has doubt about the importance of finance for economic activities. An individual, public entity, or private entity may need funds to establish a new business, expand an exist business, or meet the shortage in the cash flow of his business.

 

Types of finance

The most popular types of finance are capital finance and interest-based lending:

Capital finance includes stocks and venture capital. Stocks issued by public shareholding corporations represent capital shares in net assets of the issuers. A stock holder receives a share in profit or loss. Venture capital represents ownership of full or part of the equity of an entity.

Interest-based lending includes bonds and credits. Bonds issued by public shareholding corporations, treasury bills issued by governments. Owners of bonds receive interests. Credits provided by banks and financial institutions take the form of line of credit and loan. Borrowers pay interest. Most of Finance is made through lending.

 

Both stocks and venture capital do not suite the different needs of investors. Interest-based lending is tailored to suit the different cash flow requirements and provide opportunities for making profits through lending money without being involved in productive activities.

 

Banks normally take the legal form of public shareholding corporations. They raise funds and collect deposits. Part of deposits is retained in form of interest-free current accounts subject to unrestricted withdrawals. Most of deposits are retained in form of deposit accounts, subject to different terms, in return for interest or profit. Banks are allowed to use specific percentage of deposits to finance economic activities in return for interest or profit. They profit from the difference between the interest received from borrowers and the interest paid to depositors. In return for service fees, banks provide different banking services, such as opening letters of credits and issuance of bank guarantees.

 

On the one hand, banks play an important role in development. They invest savings of those who are not willing to take investment risk. They provide necessary funds to finance the deficit in cash flows of businesses. They extend facilities to encourage consumption.

 

On the other hand, banks play an inflationary role that inflicts greatest harm to the society. They are responsible for the excessive expansion of money supply through the money creation process. They help the progressive shift toward financial activities through providing credits to speculators. Financing charges paid by owners of productive businesses to banks are charged to consumers in form of price increase.

 

In order to avoid inflation, interest-based lending can be replaced by current equity finance which is capital finance in form of a line of credit based on sharing profit and loss. Current equity finance suits finance needs of all investors and all types of businesses.

 

Presentation of an alternative finance system

Transformation into the current equity finance requires that banks do not retain deposits. Instead, they act as specialized financial institutions. They use funds received from the central bank to provide current equity finance to productive entities. All payments and receipts are made by transfers through accounts with the central bank.

 

A current equity finance contract governs the relation between one or more partner (the customer) and the bank. It shows type and terms of finance, the profit share of every party in return for his efforts or work, and the minimum of the capital share of every partner. A partner has the right to change his capital share at any time provided that it does not go below the predetermined minimum share. The bank has no capital share. A partner may have no capital share. The central bank is a partner liable to cover the shortage in the cash flow. With the consent of partners, a bank may issue stocks to be bought by national investors. Stocks are unsalable. Investors are regarded as partners.

 

Liquidation is made by selling the net assets in cash to a third party, a partner, or the central bank. Capital recovery and distribution of profit or loss is made on liquidation date. Accounting is based on cash base. In case of profit, the profit share of every party for his efforts, knowhow, or work is paid. Capital is recovered and net profit (or loss) is distributed in proportion to the accumulated invested capital computed by using the well known “Daily Numbers Method”.

 

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Chapter: 6

Foreign currencies

 

 

In most countries, foreign currency receipts including the receipts from exports do not equal foreign currency payments including the payments for imports.

 

The excess of foreign money receipts over foreign money payments involves bearing risk since the exchange rate of the foreign currency may decline. National resources are exchanged for foreign money. The stock of natural resources maybe depleted because of the over-utilization of resources. Depletion of natural resources is made at the expense of next generations.

 

The excess of foreign money payments over foreign money receipts reduces the exchange rate of the domestic currency because it raises the demand on foreign currencies. Prices of imports rise. If imports represent factors of local production, prices of domestic goods will increase. Foreign currencies fly outside the country due to political instability, security problems, or lack of local suitable investment opportunities.

 

Under a fixed exchange rate regime, the central bank is liable to keep the domestic currency fully backed by the reserve currency. If the exchange rate of the reserve currency declines, the exchange rate of the domestic currency will decline causing inflation.

 

Under a floating exchange rate regime, the central bank intervenes to avoid excessive appreciation or depreciation. If the country is already experiencing higher inflation floating exchange rates may make the situation worse.

 

Foreign currency management

The central bank has to make concert efforts to keep both foreign currency payments and foreign currency receipts in balance through taking necessary actions:

Set effective controls to avoid smuggling foreign money and unnecessary foreign currency spending.

Encourage national production even if prices of national products will be reasonably higher than prices of similar imports.

Limit imports to the capital goods and the necessities for consumption.

Replace the method of buying foreign assets on credit by buying assets based on profit sharing equity finance agreements.

Retain reasonable foreign currency reserves to meet future and probable foreign obligations.

Set effective controls over the in and out flows of foreign currencies.

Apply restrictions over domestic currency exchange to foreign currency.

Avoid future exchange transactions and speculative activities in exchange markets.

Apply floating exchange rate regime in order to avoid black market.

 

Actions such as imposing more taxes, applying spending cut polices, devaluation of domestic currency, and borrowing are a change for the worse.

 

Since present fiat money is declared as legal tender, currency exchange transaction becomes as a process of exchanging the legal right of acquiring domestic potential products for the legal right of acquiring foreign potential products. Therefore, the key for successful foreign currency policy is to sustain the stability of the purchasing power of the domestic currency unit.

 

Universal currency

Universal currency refers to the currency which is used for settlement of foreign obligations. The measures of accepting a universal currency differs from those of a national currency. Gold is the historically accepted backing for the currency that was used in international transactions. Gold is not a gas or liquid. It is neither corrosive nor radioactive. It is rare enough to be valuable.

 

During the age of the gold standard, the British pound sterling was the universal reserve currency. After World War II, the US dollar was given this status by international treaty according to which the Fed was committed to hold enough gold to honor all its outstanding currency in gold at $35 per ounce. In 1971, the Fed abrogated its responsibilities to honor dollar for gold entirely.

 

USA was liable to convert the dollar into gold at fixed price. The international monetary system failed because it was based on a commitment that ignores the fact that gold is naturally a commodity with variable market price.

 

Since the 2008 financial crisis, the Fed has been inflating the dollar massively. Public debt grows sharply, and the exchange rate of the dollar falls dramatically. In the absence of a fair international monetary system, rights of exporters and holders of foreign currencies become questionable. Some countries try to eliminate the risk through holding currency reserve in form of a basket of currencies. Other countries start to barter their products or accept domestic currencies in exchange for exports.

 

Presentation of a universal currency

A new independent universal currency can be considered for international trade and foreign transactions if the price of each unit of the universal currency is set to be equal to a fixed quantity of gold.

 

The universal currency can be issued by an independent universal bank. The universal bank sells universal money to central banks in exchange for the appropriate quantity of gold. Assume that each unit of the universal currency is set to be equal to 1/1000 of ounce of gold; a 1 million of the universal currency will be sold to central banks in exchange for 1000 ounce of gold. Delivery of the universal money can be made in form of banknotes or credited to the account of the central bank with the universal bank. It is the responsibility of the universal bank to honor universal money for the appropriate quantity of gold.

 

The universal currency derives its value from the market price of gold. International currency exchange markets determine the exchange rates of the universal currency in terms of the different domestic currencies. The higher price of gold is the lower exchange prices of all national currencies in term of the universal currency. Prices of exports and foreign obligations are set in term of units of the universal currency which is fully backed by gold. The proposed system can be adopted by a group of countries.

 

In theory, the total balance of central banks accounts with the universal bank should equal zero, but; positive balances shall exist because of the clearing time difference worldwide in addition to the desire of retaining balances for liquidity purposes. The system cuts the global demand on gold to the minimum.

 

Taking into consideration a reasonable liquidity ratio, the universal bank can invest available balance, based on current equity finance contract, for development of poor countries. Profits can be used to cover the expenses of the universal bank and the net profit can be invested in the same way.

 

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Chapter: 7

Redistribution of Wealth

 

 

Distribution refers to the sharing of wealth among people. Growing unfair distribution of wealth causes concentration of wealth into few hands and has destructive impacts on societies; Rich becomes wealthier, poverty rate increases, and the living standard of middle class declines, crime rate rises, and the state of harmony and cooperation between peoples is replaced by a state of hate, hostility, and envy.

 

Present redistribution policies are based on extensive growth in the function of government. Policies used by governments to narrow the income gap differ according to its economic system. Socialism failed to realize its objective of equality and distributable national output declined because resources were managed by bureaucracy. Capitalists adopt some welfare systems including several forms of public assistance, such as unemployment compensation, housing, food stamps, free services, subsidies and cash aid in addition to social security and retirement systems. Welfare systems failed to ensure financial security to populace.

 

Present economies are characterized by rapid growth in the rate of poverty and enlargement of the income gap amongst people. A study by the World Institute for Development Economics Research at United Nations University reports that the richest 1% of adults alone owned 40% of global assets in the year 2000, and that the richest 10% of adults accounted for 85% of the world total assets. The bottom half of the world adults owned 1% of global wealth.

 

Economic inequality

Economic inequality refers to the income gap, or the wealth gap, amongst people. It is the main problem of developed countries that may be growing richer in the sense of growth in total output without their inhabitances growing any richer as individuals.

 

Economic inequality has existed in a wide range of societies and historical periods. Its nature, cause and importance are open to broad debate. Marxists believe that economic equality is necessary for political freedom. They favor distribution process based on an individual’s needs. Libertarians argue that it is natural to reward some vastly more than others because men are born unequal. The Capabilities Approach looks at income inequality and poverty as form of “capability deprivation”. When a person’s capabilities are lowered, they are in some way deprived of earning as much income as they would otherwise. From a Meritocratic point of view, economic inequality is beneficial inasmuch as it reflects individual skills and effort, and detrimental inasmuch as it represents inherited or unjustified wealth or opportunities.

 

There are many reasons for economic inequality within societies:

Natural differential in personal capacities

Natural differential in personal capacities affects individuals’ capabilities to accumulate wealth, no matter his work ethic. People are naturally born unequal with different innate ability, such as intelligence, motivation, strength, or charisma. Some has disability as a result of a birth defect. Others are orphans. People grow in different living conditions. A child may grow in a poor, dangerous neighborhood with poor schools and little access to healthcare. Some has disability as a result of an accident or disease. Rich tend to provide their offspring with a better education, healthcare, and safe neighborhood. Unlike poor, those who already hold wealth have the means to invest in new sources and create more wealth. Neither a child nor an old can earn income from work. Cultures, customs, genders, races, religion and diversity of preferences within a society affect wealth-acquiring behavior.

 

The different wealth-acquiring behaviors due to natural differential in personal capacities have its justification because of its role in building civilization. Every individual has different role in building the society. Different roles are necessary for people to live in the way they are living. Engineers cannot build a dam in the absence of labors. Doctors are not needed unless there are patients. Sellers cannot sell unless there are buyers. The different roles of individuals bring up the differentiation in individuals’ contributions in building the society and explain the different wealth-acquiring behaviors which are behind the existence of poor and rich.

 

Inflation

Inflation helps concentration of wealth and widens the income gap. It allows an oppressive operation which is against values of all religions, constitutional rights, and human rights.

 

Borrowing opportunity

Banks and financial institutions, normally, do not grant credits unless they get sufficient collaterals from borrowers. Required collaterals are available with rich. They can use such credits to increase their wealth, and in turn, getting more credits and increasing more and more their wealth. In the contrary, very limited borrowing facilities may be provided to small businesses and professionals.

 

Special advantages:

Feudalism gives advantage to a tiny group of people of the upper class to own land and capital while others work as servants or slaves. Capitalism allows a tiny group of rich to dominate both economy and policy through direct involvement in the ruling system or as a return for their spending on the election campaigns.

 

A simple analysis of the remedies for the 2008 U.S. mortgage crisis illustrates how capitalists govern the decisions of governments in democratic capitalism. The problem is that the mortgage loans are in default. The excessive and imprudent expansion of credit was the reason of the problem. Many governments were in a hurry to pour liquidity into financial systems so that financial entities can meet requirements of cash flows. They claim this action is necessary to protect depositors and encourage credit expansion to help stability of markets. The solution is based on excessive expansion of money and represents a reward to those who created the problem. In addition to the huge profits which financial institutions generated in previous years, public money is used to bail them out of the crisis. Better results could be achieved through direct support to borrowers by rescheduling mortgage loans based on lower payments and interest.

 

As the community has grown in size, organization, and complexity, so the services provided by governments have increased. Governments provide public services, in addition to some other services and assistances to poor and those of limited income. These services have to be paid for. Taxes are imposed on individuals and businesses.

 

Taxation is viewed by economists as a redistribution tool. In fact, taxation is an inflationary financial transaction which increases cost of services provided by the government, helps concentration of wealth, and widens the income gap.

 

Presentation of an alternative redistribution system

A sound redistribution system has three main objectives:

To cover the deficit in the government budget (if any).

To keep up all members of the society at or above a specified material standard of living.

To help removing the burden of the welfare programs, social security systems, and retirement plans.

 

A government is liable to provide all members of the society with public services including defense, internal security, judicial services, education, and health care. Government budget may show a deficit because public revenue may not cover cost of public services. Also, a government has to recognize the right of every individual to live at or above the specified standard of living. Such recognition requires that every individual can afford paying for the standard cost of living.

 

Since all members of the society, regardless of their wealth, benefit from public services, they are liable to cover the deficit in the government budget (Nothing for free). Recognition of the liability of all members of the society to recover the government budget deficit requires that the deficit is to be charged evenly among all members of the society.

 

Individual’s standard cost of living includes the individual’s share in the deficit of the government budget. Individual’s standard cost of living differs according to age, gender, and family size. It is not a stable figure. It can be changed according to the changes in development needs, service mix and living standard in the community.

 

The standard cost of living of a family equals the sum of the standard cost of living of the household, the spouse, and all dependants in the family taking into consideration the number of the family members.

The income of a family equals the sum of the income of the household in addition to the amounts paid by the spouse and dependants to the household as contribution to family expenses. Income includes capital gains.

 

Since rich have the interest to maintain social stability and continuously acquire contributions of others in building the society, rich have to compensate poor and those of limited income in order to keep them living on a reasonable standard.

 

A progressive wealth duty is to be levied annually on the excess of the family income over the family standard cost of living. The duty is to be also imposed on the excess of the income of the spouse or the dependent over his/her contribution to the family expenses. Wealth duty is used to cover the deficit in the incomes of the families of incomes less than the standard cost of living. The household’s account with the central bank will be charged annually by the total shares of the family members in the deficit of the government budget.

 

Unlike present taxes, wealth duty is not public revenue. It is not imposed on products. It is not levied on productive entities. It will not produce inflation because it is not an element of the cost of products.

 

Additional wealth duty may be levied to finance requirements of emergency cases such as war and natural catastrophes. The additional amount of wealth duty may extend to absorb all the surplus wealth over the limit of the standard cost of living. In case of insufficient duty, all people ought to share responsibility through a decline in the amount considered as the standard cost of living.

 

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Conclusion

 

 

It is obvious that present economic systems were designed to benefit rich through producing inflation. Wise management of resources and transformation of present inflationary economies into pure productive economies are the keys to structure a sound economic system.

 

Some economists have become aware of the inflationary role of money. The Congressman Dennis Kucinich introduced the act HR2990. It is stated that, the purpose of this act is to create a Monetary Authority which shall pursue a monetary policy based on the governing principle that the supply of money in circulation should not become inflationary or deflationary. The recommendations include reconstruction of the Federal Reserve, establishment of the United States Monetary Authority, conversion of Federal Reserve Notes to United States Money, abolishment of the creation of money by private persons through lending against deposits, and replacement of fractional reserve banking with the lending of United States Money.

 

Unlike present inflationary economic systems, the proposed alternative system is free of inflation. It introduces pure productive economy. It is fair, integrated, and self-correcting system. It is base on reality rather than prediction. It is dynamic in such a way to comply with present complex requirements of societies and accelerated technological improvements.

 

Implementation of the system will result in economic stability, steady optimal growth and full employment. Prices will decline, value of currency unit will be stable, national output valued at real market prices will rise, exports will increase, and imports will decrease. Public debt will decline. Private property will be protected with consideration given to the right of all people to enjoy fair living standard.

 

The alternative system benefits all people and provides better investment opportunities, but it is not in favor of corruptors and will be confronted by those who dominate both productive and financial markets.

 

The views expressed here are undoubtedly drastically different from the views of other researchers. However, financial distress is increasing and people will, sooner or later, realize the truth and make concert efforts to gradually embrace an alternative system that would reflect fair economy, and advance the needs of humanity as a whole.

 

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Pitfalls in Economic Thinking

One of the main functions of a government is to sustain all its population at or above the prosperity level which expresses the feasible material standard of living that an economy can provide. Governments failed to realize prosperity. Financial distress is increasing. Corruptions are going on around the world. Poor is becoming poorer. Living standard of middle class is declining. Relatively small number of individuals and corporations are controlling huge pools of capital. Public debt is increasing. Confidence in currencies is deteriorating. In order that an organized body of knowledge might be classified as science, its hypothetical law must be based on facts. Unlike any other social science, fallacies are the root of the technique of thinking in economics. It is time to change. This book aims to discuss in simple wording each of the factors that causes the failure of the present economic systems to realize prosperity, highlight the pitfalls in economic thinking, and introduce an alternative fair economic system that would reflect fair economy and advance the needs of humanity as a whole.

  • ISBN: 9781370796007
  • Author: Maher Kababji
  • Published: 2017-03-19 06:35:11
  • Words: 11989
Pitfalls in Economic Thinking Pitfalls in Economic Thinking