Tuesday, September 18, 2012

Louis Kelso - The Binary Economics

In one of my over the whiskey discussions, we explored the idea of consumers investing in the stock of the companies from whom they buy products.  The basic idea was that if company is making profit from me, it will probably reflect in the stock price of the company some day. Google search for any precedence lead me to Louis Kelso and his theory of binary economics. He was the inventor of the ESOP.

I don't think I buy the whole argument, but the intentions feel solid. The core premise is that any increase in production should happen with equivalent increase in purchasing power for the economy to function properly. This I think is a gem of a observation.

Consider an economy in perfect equilibrium. Lets say someone invents a new thing and everyone wants it. This would require people to buy less of the other stuff so that they can buy this new thing. Which means less prices for everything else to save money for the new product. The introduction of new thing causes prices of rest of things to be recalculated so that economy is in balance again. What is required here is that either magically everyone has enough money to buy the new thing or price of everything else is "adjusted" so that everyone has enough money for the new thing. That is not what usually happens. Multiple things can happen at this point. Some people might reduce the use of other things to save for the new thing. Some might use their savings. Some take debt. Some don't care. Unlikely, but some may increase prices to get more margins. And some may invent new ways to reduce costs to get more margins. If most people reduce the use of things, demand goes down, some other people make less money. That would be a start of slowdown. If most people use their savings, the cost of money goes up, interest rates are increased. This might cause defaults, as wages were untouched. This might make some businesses suffer, whose margins are less than the interest rates. What we really need here is a perfect kind of transformation. Some people save, some use the savings, some take debt and somehow everything cancels out, without impacting money supply or margins for existing businesses. The point is economy doesn't seems to tend towards equilibrium, when moved away from it.

If some of the people make most of the money then most of the people will not have much money. Compound it with money makes money, you end up with lots and lots of poor than you started with. The end result would be decrease in market size. Some of the people just can't afford some of the things anymore.  This can be offset by technological advancements to decrease the cost of production but only up to a point. All businesses need consumers, but if businesses are run for maximization of profit alone, they may end up destroying the very thing namely consumer which is the main source of profit. One way to make things affordable in short term is debt, but sooner or later the things will collapse if consumer cannot even pay the debt. Seems like this is true even for countries. Historically, the only way to deal with such situation (inability to pay debt) was handled using slavery.  So maybe that is really the end goal of obsession with money.

The funny thing is I heard one gentleman saying he is looking forward to depression because he knows how he can make money from it.  That I think is very sad state of affairs. If the only way to deal with correction of the economy is depression, then something is fundamentally wrong about the system. We use vote to decide who will run the country. We might as well start killing each other to show who is more powerful. That would be absurd, except that is how I think we deal with financial systems.

One of the ways to deal with this could be use of communication on the demand side of things. What Groupon did was something which was not possible for long time. Unknown buyers joining to bargain product prices. Kickstarter is doing the same, except for funding new products. What should I call it - consumer union?  Just like labor unions used to stop work and cause financial loss to company, may be consumer unions can stop purchasing the products of the company to bring it to halt. That is what Gandhi did to British clothes. This was not possible earlier because consumers never knew each other because of physical distances. It was not possible to discuss, but given the communication systems of today, this is very likely.

If the consumers own the company stock, we still have a fair arrangement, except it is much cleaner.  The margins flow back to the consumer automatically.  This could even be used by governments when they give natural resources to companies. The current best practice is auction. What if government could use half of the money from auction to buy the stock of the company to which it is selling the contract for natural resource like coal mine. What it does is that it insulates government from any bad deal it got while selling the resource. If the company got less, its stock price will not rise much. If the company got more, its profits will reflect in its stock prices, giving more value to the government. 

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