Economic Momentum 1 & 2

Factors destructively affecting the Momentum of an Economy

Economic Momentum 1

Physical systems are relatively easy to explain in precise mathematical terms & models, however Economic systems (effected by social, political factors) have to be approximated through trial & error, analysis & observation.

Economists look at the changes of variables to estimate macro change & predict future trends. For example we hear much of year-on-year, annualised monthly, change of GDP, inflation, and other components – but these do not give an immediate insight or feel of the dynamics of an economy or what dynamic effect a particular change in a control component has upon an economy.

Therefore look to a more dynamic measure and how Interest Rates as an economy control device influences this.

In physics:

Momentum = Mass x Velocity

This gives a “feel” of motion, but more importantly a feel for the amount of force necessary to produce a change in the Momentum of an object.

A cricket ball weighing (what?) 500grammes batted away by Graeme Smith at (what?) 150kph can be caught in the hand (the momentum of 0.5Kg x 150kph = 208 kg-m/s). It is possible to reduce the speed of the ball from 150kh (batting) to 0kph (catching) with ones hands.

However Michael Schumacher sedately driving his Ferrari weighing (what?) 3000kg at 150kph has a momentum of (3000 x 150 = 125,000 kg-m/s). It would require 600.96 simultaneous ball catches to stop his car.

But Michael’s car has sophisticated braking systems to control his deceleration. If he detected that the braking system (or conversely) the accelerating system were not operating correctly he would report it to his mechanics for immediate repairs. So, if for example, he presses on the brake pedal and a disk pad binds up his car becomes unstable and begins to skid - depending on how severe this was he could either regain control and return to the pits or he could find himself leaving the track and ploughing into something thus wrecking his car.

The point to realise here is that a control device if not correctly designed & maintained can cause catastrophic failure

Economy’s are no different, if we use control devices that are incorrectly designed, utilised, & maintained we can have catastrophic results. The time frame between Michael’s situation and a country’s economy can be month’s, year’s in difference. If Michael regains control he will pull into the pits at the next rounding of the circuit – but societies literally have to hope & pray for common sense to prevail (and God is renowned for taking his time).

(An example: Zimbabwe had independence for approximately twenty years before it totally collapsed due to government manipulations; which manipulations were caused by frustrations because the economy/social control devices were not correctly designed for a predominantly 3^rd World Country. It is also useful to compare how rapidly (less than 2 years) the country declined (lost Momentum) when the present government “redesigned” certain controls; compared to the hot-war scenario where the then Smith government maintained 1^st World control devices and in which the present government were fighting for independence for some 15 years. This example gives an indication of the importance of designing economy control devices so that it correctly controls an economy.

1^st World controls are not suitable for 3^rd World environments!)

Economics does not appear to have an analogous measurement to Physics for Momentum. So we need to develop this and see what effect an interest rate change has upon an economy. (This is not presented as a concrete theory – but merely a start to developing one).

If we postulate then

Economic Momentum = Mass x Velocity

We need to determine what are the Mass and Velocity components in economic terms.

MASS

Perhaps first think in terms of a listed business entity. The immediate thought is that Market Capitalisation (No. of Shares in issue x Ruling Price) would be a reasonable measure for Mass. But the share (ruling) price is determined largely by emotion. (A similar argument can be used for the exchange rate of a country – an exchange rate to a country is what a share price is to a company). Further, the true value of anything is determined by a flash, auction, sale (?). We are wanting (partly) to obtain a feel for the effects upon an entity (company or country) of an interest rate change. This so that we can determine the effectiveness of interest rates as a control device. It is intuitive that an increase in interest rates simply sucks money out of a company/economy and solely into the private banks as additional, unwarranted, profits. Therefore we must consider what the effect this has to the collapse (bankruptcy) of an entity. In the event of a collapse, and as we’ve seen with the unlawful, fraudulent, collapses of Tigon, Shawcell, PSCGG by State Authority & Legal persons, it is clear that the value of an entity is determined by a flash sale. It therefore becomes highly subjective prior to the event as to what the value (mass) of any entity is.

But consider what causes an entity to collapse (i.e. boundary condition) – very simply, a sustained negative cash and cash flow position. In such circumstances this is kept secret by the persons in control until such time that the entity can no longer meet its financial obligations. No matter how large (measured historically in Market Cap terms) an entity, if it cannot meet its obligations it is quickly collapsed and sold off at auction prices. The entity has no doubt already gone through the process of selling off unwanted assets to attempt an internal rescue. One could argue, in the case of a country, that mineral resources could be mined to produce cash & flows, but once it is known that a country is in difficulty and is selling of minerals in desperation the price simply drops. (A simplistic argument admittedly)

Cash & cashflow are the lifeblood of an entity – it is an easily measured component and clearly shows that when moving beyond boundary conditions catastrophic results are realised, exactly as can happen with Michael going into a uncontrollable skid.

It appears then that cash resources & discounted near-cash resources would be an appropriate measure for Mass. In other words Money Supply, M_s = Mass

VELOCITY

Income Velocity of Money, or simply Velocity of Money, is defined as

Velocity (V) =Y/M_s or Y = VM_S

Where Y is the National (or entity) Product, and M_s is the Money Supply.

Where changes in these parameters are small (less than 15%) then this equation can be approximated as

Y/Y = (V/V) + (M_s/ M_s)

(cribbed from economics text books)

We are ultimately wanting to derive a “feel” for an economy’s momentum and the effect the government control device (interest rates) has upon the economic momentum.

If we change the Money Supply (an instantaneous result of changing Interest Rates) it does not immediately come about that the National/Entity Product is effected. People have a knack of maintaining output because (for example) salaries are paid monthly, workers wanting to keep jobs can spur themselves on – it takes time for Macro factors to become effected. We therefore assume that there will be no instantaneous change to National Product i.e. Y is zero. Consequently: Y/Y = 0

Giving us

0 = V/V +  M_s /M_s

Or V/V =  M_s / M_s (ignoring sign change)

Rearranging for V = M_s (V/M_s )

Recap: Momentum = Mass x Velocity.

Mass is simply the M_s (Money Supply)

Therefore:

Economic Momentum = Mass (or Money Supply, M_s) x Velocity (or M_s (V/M_s ))

Which gives us:

Economic Momentum = M_s² x (V/M_s )

It appears then that a reduction in Money Supply brings about an exponential reduction in Economic Momentum.

If the Money Supply reduces by 10% to (100 – 10 = 90%) the Economic Momentum will reduce to (0.9 x 0.9)  81%. i.e. a 10% reduction in money supply causes a nearly 20% reduction in Economic Momentum. If a 25% reduction in Money Supply to 75% level then the Economic Momentum will reduce to (0.75 x 0.75)  56%.

Historically the Money Supply has varied between the ranges of 2.5% to 28% approximately (see graph EI-M3 below – scale is 500 = 5%), these are wide fluctuations that have dramatic exponential changes upon the Economic Momentum which cause economic instability. We’ve been observing severe economic instability in SA for years

Interest rate changes (in SA – see EI-PRIME graph) have generally been in the order of 0.5% to 1.5% steps, with an absolute change of 4% between Sept 01 to Sept 02, and a 7.25% change in 1998. An increase in Interest Rates has the effect of immediately reducing the Money Supply of an entity as money is sucked out and into the hands of private banks as additional profits. This has the effect of reducing the ability to pay creditors, and in turn creditors from paying their creditors. So any entity has its Money Supply reduced directly by an increase in interest payments to the Banks, but also by reduced debtor collections, and no doubt by its increased bad debt write-off’s.

The crucial point to be realised is that the link between a Money Supply change and Economic Momentum is of an exponential nature and that Money Supply within an entity/economy is reduced by an Interest Rate increase:

• directly (instantaneous effect) by increased interest payments

• indirectly (delayed effect) by

  • reduced debtor collections (most likely) – (short delay)

  • reduction in purchasing power as a result of general price increases – (longer delay)

Money Supply is a variable both direct (e.g. change in credit laws), and indirect (e.g. change in interest rates).

It is important to rethink the effect of zero Money Supply, an entity or economy catastrophically collapses i.e. it no longer has Economic Momentum, regardless of the “value” of its non-cash assets.

The degree to which an interest rate change will effect an entity/economy is determined by its liquidity and indebtedness. Generally used ratios such as Debt-Equity, Interest Cover etc. are not appropriate for this as they are too limiting.

It is necessary that entities analyse their own positions and formulate the necessary ratios that they are comfortable with as the interest rate fluctuations in SA are large

In broad outline, and as a first-pass in establishing ratio/s

Money Supply Reduction Ratio = Interest Payment Increase per 1% rate increase/(Surplus Cash & Discounted Near-Cash)

Surplus Cash is that remaining after all overheads & expenses are paid

Discounted Near-Cash includes debtor, stock, and any other realisable non-essentials

In Conclusion:

It is clear that in economic systems in which interdependencies are many & wide, and with varied time delays within each, that the Interest Rate control device effecting the Money Supply, which consequently results in exponential changes in Economic Momentum, can only produce chaos. Which results are observed throughout the world, daily. Destructively so in 1st World, catastrophically so in 3^rd World.

It is clear therefore that there is an urgent need to design an economy control device (Interest Rates) so that smooth changes to Economic Momentum are achieved. The previously suggested approach appears to be the most appropriate, vis: that old loans should not incur interest rates increases, i.e. only new loans should. In this way it diminishes/removes the unnecessary direct effect of Interest Rate changes upon the prevailing Money Supply, and the consequent exponential effect upon Economic Momentum, thus achieving smoother control and greater economic stability & well-being.

Comments?

Chris Addington Pr.Eng.

CDADD Consulting Services

(+27) 83 962 7098,

Graphs –> SCROLL TO BOTTOM

Economic Momentum 2

Summary

E=cM_s² (Economic Momentum is equal to coefficient c times Money Supply squared)

Apologies to Albert Einstein (UPDATE Einstein was wrong) ,

and also to Cameron Diaz for creating further confusion - see e=mc² by David Bodanis. (ISBN 0-330-39165-8)

e does NOT equal m c squared

E=cM_s² is more constructively profound than Einstein’s destructive & incorrect e=mc²

 

IMPORTANT NOTES:

1. Do not become deflected by the derivation of Economic Momentum. Intuitively there is such a concept as Economic Momentum, what the mathematical relationships are is secondary to the important & intuitive issue of the massively destructive nature of the “interest rate” being linked as a “time cost” to the “economy control device”. It needs to be de-linked.

2. It has been argued, without substantiation, by others that this derivation is tautologous. Consider a water tank with a gravity flow outlet. The outlet flow velocity is proportional to height. BUT, height is proportional to mass of water, therefore velocity is proportional to mass.

3. Further consideration of the mathematical relationship does tend to suggest that the exponential factor is itself a variable

   1. a 3^rd Worlder would probably have a higher exponential value than 2.

   2. the exponential value is piecewise variable within any economy

Recap from previous articles:

E= cM_s² or Economic Momentum is proportional to the square of Money Supply (M_s²)

• Multi-component interest rate:-

CPI

Profit

Risk

Service

Fiscal Control

• CPI - self regulating, non-taxable, value protector

• Profit Risk, Service, market determined within bounds

• Fiscal Control Interest Rate

  • Upwardly capped downwardly mobile

  • Only new loans affected by Fiscal Control interest rate increase

  • Payments flow into Treasury, not private bank coffers.

Exchange Rates

Exchange Rates between currencies are affected by, or are a function of, (interest rates, inflation, emotion, speculation)

X = f(i, I, e, s)

but it is important to note that each of these individual terms are mutually inter-dependent on all the other terms.

It is necessary to extract some basic principles.

Given a basic two country scenario:

Countries A and B, in a constructive environment, will co-operate to obtain optimal efficiencies between themselves. Trade of commodities will take place and the supply & demand for currency exchange, based upon the underlying trade requirements, will follow.

Thus - if one unit of currency A = one unit of currency B and the interest rates, Inflation, emotion & speculation are identical in both countries then the currencies will retain parity. If B has an interest rate differential of 10%, then in any particular period the currency exchange rate, all other factors constant, will offset by exactly the same10% - this is a technical shift in currency exchange rates.

Inflation is driven by markets; the supply & demand, emotions and speculation. Interest rates are used to control inflation, but it also directly impacts upon prices, growth, emotions, speculation, all of which in turn also affects exchange rates.

But currency is in itself a commodity which is traded daily – it is this trading, speculating, on currencies that account, in the main, for the difference between the technical shift in exchange rates and the actual shift.

This is important to note: Exchange rates are not demand derived from exports/imports they are speculation driven.

The exchange rate is simply then a particular country’s share price, but which can be manipulated by collusion. Small volumes of trade creates a massive impact upon the emotions, inflation, and consequent interest rate levels, which all feed back to further rounds of speculative trading. (see also SASI 2004 - Global Instability, article Instability of World Markets (Bourses))

Data streams of global economies show huge instability between currencies - these impact destructively internally, and also externally to other countries. To under developed countries currency shifts are catastrophically destructive.

If one hopes to achieve a meaningful shift to the dividing line problem then it becomes clear that thought needs to be given to the destructive nature of currency trading.

Chris Addington Pr.Eng.

CDADD Consulting Services, Broederstroom, NWP, South Africa

(+27) 83 962 7098,

Source for Graphs: Progressive Download Services (+27 11 622 6767)

Source for Economics info:

Principle of Economics – Henderson & Poole,

Macro-Economics – Dornbusch, Fischer, Mohr & Rogers.

Chris Addington Pr.Eng.

CDADD Consulting Services,

(+27) 83 962 7098,