The Imbalance of Payments

It has commonly come to be believed that what is generally associated with the fallacy known as the “balance of trade” exists and represents a real effect. Although propagated, the myth is one that needs to be relegated to the dustbin of history or, at the least, assigned to the flat-earth society.

To explain the misunderstood concept more clearly, it is best to simplify it and not confound the issue with the added miasma of obscure relationships that create a society or nation. To do so, I would start with a household balance of trade, that is, the income and expenses for a household. If we take a common family group of two working adults and two children under the working age, we see two sources of income and four direct-expense sources (which we can think of as the states).

Each adult has an income from an employer and possibly some smaller amount coming from a hobby or side occupation. Let’s assume that partner A works at a department store and has a hobby income C, and partner B is an engineer. In our instance, there are three sources of favourable trade balances: partner A’s employer, partner B’s employer, and any person who purchases from partner A’s hobby side business.

Each of them poses what is commonly deemed a “favourable balance of trade” as a commonly misapplied term. Partner A and Partner B each have a positive balance with their respective employer. But, partner A’s hobby income breaks even. Which means it is a balanced trade source. 

Partner A in our scenario has the responsibility (they are not pooling their income) for food and school fees. Partner B has the responsibility the rent and entertainment. Each partner supplies the children with a small sum each month. We will for simplicity assume that our family is rather ascetic and wants for little. We will also assume that 50% of the expenses for food go to the same store that partner A works at and that the other 50% go to the grocer.

In our scenario, we have a favourable balance of trade with the department store. Here we see the following equation:

  • (partner A’s income) — 0.5(food expenses) = positive trade balance with the department store

We see a positive balance of trade as partner A is unable to spend the entirety of his income — by the fact that it is split across several parties — at the department store where partner A is employed. Partner A receives the amount of (partner A’s income) from the department store, but spends 0.5(food expenses) at the same store.

We then see a negative balance of trade for partner A’s dealings with the grocer and partner B’s dealings with the landlord. In each instance, we can represent the scenario mathematically in the following way:

  • 0.5(food expenses) = negative balance of trade with grocer
  • Rent expenses = negative balance of trade with the landlord

In each example, we have a negative balance of trade. Let us presume that partner B earns 150% as an engineer of what she could earn as an estate agent working for the landlord. Partner B could sacrifice some of her time employed as an engineer and work for the real-estate agent (the landlord). Let us assume that partner B works 40 hours a week and that 40% of her income is assigned to the rent.

Here, we see that 16 hours of partner B’s time is associated with working to pay the rent (40% times 40 hours). An option exists where partner B (we presume she is talented and can be either an estate agent or an engineer — as she wishes) can work for her landlord part-time by sacrificing some of the time spent working as an engineer.

Working for the landlord, she earns 66.67% of her earnings as an engineer (the reverse of 150% as noted previously). It means that she must, by needs, work a longer time to generate the same income. In other words, in order to earn and then pay for the same value of rent, she must work longer hours. As the income from the landlord corresponds to only 66.67% of her earnings as an engineer, she must work 1.5 times as long for the landlord. That is:

  • (required work effort for landlord) = 1.5 x (required work effort as engineer)

As partner B works 16 hours directly for the payment of rent, we can express the previous equation as follows:

  • (required work effort for landlord) = 1.5 x (required work effort as engineer) = 1.5 x 16 = 24 hours

In our case, partner B is still working 24 hours (40–16) as an engineer, but needs to work an additional 8 hours overall (resulting from the 24 hours of work at the landlord — as opposed to the 16 hours of work as an engineer instead). 

So we have two scenarios already: partner B can engage in the most efficient source of trade (working as an engineer), or she can seek to minimise deficiencies in the “balance of trade.” As partner B is working in her optimal trade position and creating several “unfavourable trade balances,” partner B is better off. She needs to work only 40 hours to have the same standard of living that she would have if she was working 48 hours with a “more favourable trade balance.”

The scenario is the same if you substitute companies, states, or nations for the partners. We could also argue in our example that the children form an unfavourable trade balance, which could be removed by removing the children. Such is the nature of the anti-trade and protectionist argument.

The argument of course begs the question: why do governments perpetrate such a lie?

The answer lies in inflation. Most people have little understanding of the economy, and few people seem to want to spend any time explaining it in simple terms.

Inflation — the Hidden Tax

What is inflation, and why does it occur? The answer is far simpler than many like to say. There are many complex reasons that can be used to explain inflation, but simply and completely, inflation is the result of an expansion in the money supply. There is only ever one cause for an expansion of the money supply: more money.

The creation of money is a monopoly of the government. In modern Western nations, the reserve-banking system (as it exists with the US Federal Reserve or the Australian Reserve Bank) means government institutions. Such is the case even (as in the US) where the reserve-banking function is “nominally” of private concern. In all instances, policy is either set or, at the least, influenced by the government.

Even in the event where government was independent of policy (which occurs in no existing context), the additional money manufactured through inflation goes to the government. It is in effect an indirect and hidden tax.

If the inflation rate is set at 5% for a year and the total money supply for the economy is $1,000,000 (low, I know) at the end of the year, the total money supply will now be $1,050,000. In other words, the government has printed an additional $50,000 that did not previously exist. As the gold standard does no longer exist and as it is no more expensive to print a $10 note than it is to print a $100 note, there is no cost to the government in doing so.

So at the end of the day, we have an economy with 1.05 times the supply of money, but no additional productivity. Productivity is a function of companies and individuals. In contravention to what governments (right or left or centre) would have you believe, they do nothing to aid productivity other than not hindering it. That is, they can stay out of the way. It is a reduction of a negative effect at best and never a positive one.

So what does the extra money supply mean?
Without an increase in productivity, additional money has a negative effect. There is the same amount of goods and services in society, there simply is more money competing for the same goods and services.

To demonstrate the scenario, imagine that the government uses the $50,000 they have created to pay its people. To now purchase the same amount of goods, there is more money available. As such, if you want to have the same goods, you can pay more for them (as can others). The increase in demand (added money) causes prices to rise. Hence the effect of inflation is an increase in prices. Price rises are the effect of inflation and not, as often argued, the cause. The lie is perpetrated to keep people in the dark about one of the most insidious taxes.

As there are no new sources of productivity, the overall market will shift to consume the entirety of the new volume of money. As such, a product that formerly cost $1 will now cost $1.05. The salary of $50,000 will increase to $50,250. The end result may seem to have no change in values, or is there?

The reality that is frequently ignored is that there is an addition of money in a fixed location as the created money goes to the government. The created $50,000 is not distributed to all members of the nation; it is assigned to a single party.

The effect is that price rises will occur, but value will be impacted upon the individual. There will be a lag in pay rises and other effects (which the government can later use to justify the next round of inflation).

So, what is the result?
The sole result is a hidden tax. In effect, the item that cost $100 prior to the injection of more money by the government now costs $105. As such, each $100 a person earns can now buy a pre-inflationary amount of $95.24. That is, $4.76 has been lost (or at least reallocated to the government). As the government has the newly printed money to distribute, it comes in the form of a hidden means to taking money — in effect, a tax.

What it all comes to is that a 5% inflation is in reality a 4.76% hidden tax.

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