Economics Notes
By: Yvette Q. Xu
March 28, 2003
I. Scientific Methodology Cannot be Simply Applied to Economics
Anyone with science background will avoid talking about economics, since the current economics does not provide the predictable result as science does. Although the current economists tried their best to simulate the market by the similar format as the format used in science, it still can not reach the rigorous standard as science does.
Economics belongs to social science, while social science has totally different nature from science. People’s thinking mentality is limited by the success of science, which has the nature of repeated phenomena, in other words, science only deals with “Time-invariant variables”. In science, our confidence is built on “experimental verification”. But social science, especially economics, the phenomena can never be exactly repeated in the future; it deals with all kinds of time-variant variables.
Other than “experimental verification”, there are some other criteria providing the base of confidence, which are logic and mathematics. Based on mathematics and logic, we can build a deterministic decision making system. This is the first step for us to learn constrains of our social behavior and leads our economy to a relatively stable situation.
II. All Economic Problems are Man Made Problems
Let’s have a deep breath, calm down our mind, ignore all the messy, vigorous, seemingly complicated economic formulations, and think at the very fundamental level and answer one question: what are problems in economics?
We learned science from nature, we made innovation to increase our productivity; if we exchange our goods at a fair price, our government issue the correct amount of money supply and set the correct interest rates, there will not be any economic problems. In other words, all the economic problems are man-made problems.
God has built intelligence in us, we should be able to find out the law of nature, which govern our social behavior, and use them to design a workable, good economic and social (political) system just like we did in science.
III. Basic Economy
Three requirements contribute to a stable economy: the rational ranking of basic rates, the price determination and the correct money supply.
A. Basic rates in economics:
There are three basic rates in the economy: inflation rate, interest rate and investment rate of return. The rational ranking for these three rates are:
1. The inflation rate should be higher than zero to encourage investment .
2. The interest rate should be higher than the inflation rate. It will keep all the banks and financial institutions in operation. If the inflation rate is higher than the interest rate, people will save goods instead of saving money in the bank.
3. The investment rate of return should be higher than the interest rate. This rule is obvious, otherwise there is no investors will borrow money from the bank. This is also the reason that the inflation rate cannot be too high.
As far as the ranking of these three basic rates is in correct order, the economy is normal.
Now the question is how to determine certain kind of investment rate of return? This in turn will determine the interest rate to be used for that kind of investment.
B. Money supply:
The Noblest Mr. Milton Friedman has discovered a time invariant in economics, the relatively constant velocity of money circulation, and his famous equation: PQ = VM2 is the base for the government’s monetary policy.
In this equation:
V : Velocity of money circulation, which is relatively constant in time, but varies in different countries or regions.
M2 : Broad money supply in business circulation includes cash, credit, paper notes, … and so on.
Q: Total products in general, which includes all kinds of products, businesses and properties.
P : Price, this is the most important factor need to be figured out.
Since V is constant, M2 is controlled by the government; the variables left to the market are Q and P. There are three major economic phenomenons:
1. Inflation:
At one time slice, Q is fixed, too much money supply will make P goes up, which is called inflation.
2. Deflation:
When the money supply is unreasonably restricted by the government, P will go down. This is called deflation.
3. Recession:
When the price P gets too low, the inflation rate becomes negative; the rule No. 1 is violated.
The economy slow-down will weak or destroy the investors’ confidence. When businesses lost investor’s support, the shortage of capital (M2) will force them to reduce production (Q) or go bankrupts in the severe cases. One sector’s depression will spread out as chain reaction.
Two consecutive quarters with negative economy growth indicates recession.
In order to stimulate investment, the government cuts interest rate to keep investment rate of return staying higher than interest rate. Since interest rate has to be higher than inflation rate and lower than investment rate of return, its range is limited.
The government’s role is to provide the correct money supply to avoid both high inflation and recession. In order for the government to figure out what is the correct money supply and how to set the interest rate for different investments, the key point is to find out the investment rates of return for different investments, which together with the interest rates will determine the prices.
If both money supply and prices are determined in the correct way, economy stabilization could be achieved.
C. Price and investment rate of return
Price is the key for business and for decision-making. Fair prices will settle business deals between buyers and sellers and will bring peace in the international arbitration.
Price and investment rate of return have reversing relationship for investors at different time. In order to achieve high investment rate of return, they prefer lower price when they are buyers and higher price when they are sellers. The rational price determination has to be fair to both buyers and sellers, and the same logic has to be carried all the way to time infinity to secure all the future investors. Under such condition, both buyers and sellers are under the same protection.
Business has no space limits. International trades; stock markets; oversea investments have broken the national boundaries. Therefore the price determination has to take all the space factors into consideration. The space factors will be reflected by vacancy, inventory-production ratio, market demand for same kind of business and industrial chain interaction among different industry sectors.
Investment return can be expressed as two parts: monitory return and non-monitory return. The monitory return is measured by its profit margin, while the non-monitory returns are the differences among all kinds of investments other than the differences in their cash flow, such as the risks, management difficulties, and special values as personal or cultural, political concerns and so on.
For all kinds of investments, the total return including monitory and non-monitory should be in the equilibrium condition as being adjusted by the free market. The higher risky and more difficult investments need higher rate of return to attract investors. The more secured and easier work only deserves lower rate of investment returns. In the long run under stable economic situation, certain investment will have a constant rate of return since they have the same non-monitory return.
In summary, price determination needs a system including all the factors with a consistent logic to space and time infinity.
IV. Infinite Spreadsheet
There are a lot of so-called “Mathematical Economic Models” in today’s market, but none of them presents an inclusive and deterministic system. These methods are simulating the market, modeling part of the system; the results from all these methods are arbitrary. Without taking all the factors into consideration for disclosure and having the consistent logic to time infinity, all these methods can be categorized as finite spreadsheets.
Social scientists, economists make their arguments in pieces. Searching on the stock market Internet web sites, from television news, we see the economic experts talking about quotes, earnings, growth rates, dividends, P/E ratios, all kinds of performance indicators, but without a system for disclosure, the variables are at the loosing ends, you can assign any numbers to them, and helplessly accept any consequences from your decisions.
In mathematics, a system with number of unknown equal number of equation provides a deterministic system. The infinite spreadsheet designed by Post-Science Institute is based on this rule, it is inclusive as it has taken all the variables acting in the investment into consideration for disclosure and follow exactly the reality of their relationship and carries this logic to time infinity to reach the value of the final variable in the system, which can be either price or rate of return or any item expected.
The infinite spreadsheet provides a yardstick. We can input values for all the variables defining an investment environment, such as interest rate; operation cost; gross income; growth rate, tax benefit; vacancy factors; expected rate of investment return … and so on, the system will determine the last variable, in most case, it is the price or the investment rate of return.
For certain type of investment, the expected rate of return is relatively constant; therefore the price is determined under a defined investment environment. When the market price keeps going up, the investment rate of return will go down. When the investment rate of return gets below interest rate or even goes negative, the market is called overvalued.
The overvalue phenomenon was clearly demonstrated in 1980s’ US real estate loan default. The real estate market overvaluation in 80’s was detected by Post-Science Institute (World-Wide Valuation Institute.) They did contact Mr. Alan Greenspan at that time, but there were no responses from him or his staff. The savings and loan institutions did not realize the fact, they lend out money according to the overvalued market appraisal of the properties. When the market finally crashed in 1991, all the loan values got lost. The lost in this savings and loan crises was estimated from half to one trillion dollars.
V. Irrational Behavior in Stock Market
Stock market is a purely monetary system. It has eliminated most non-monetary factors such as management headaches. The function of stock market is make funds available to support the innovations.
The stock price has two components, the fundamental value and the market instability. The fundamental value reflects the business performance, and the market instability reflects any psychological impacts and blindness due to lacking of knowledge and confidence for the fundamental evaluations.
Regardless how are the investors acting, the market in the long run will oscillate around the fundamental values. Periodically crash is the market correction to the overvaluation; and the market rally will bring the price out of the bottom.
Without education, influenced by rumors and political climate, people are guessing the market direction, their behavior only amplify the market instability due to the finite considerations. When the market is going down, the sell is strong, that will make market overshooting the fundamental value to enter the undervalued region. While when the market is going up, people’s buying force makes another overshooting and bring the market entering the overvaluation region.
If all the investors realize that the infinite spreadsheet is unbreakable mathematical law of nature applied to social science, which control the market prices, as far as we do not violate the law of nature, the market should not crash and the economy should not have recession 。 T he only variation for the price should be caused by the business performance, technology testing and improvements, which is much solid and predictable, they will be very confident to utilize the infinite spreadsheet as an evaluation tool to make their investments’ decisions. Same like we did in science, people get educated in using electricity, automobile and internet, the investor also need to be educated to understand the nature of the economy and the constrains of out behavior, such as use infinite spreadsheet to calculate the price before they investing their money in the market. If there is good percentage of investor realize the law of nature in social science, the market will never need to crash to be correct and the stable economy will be achieved.
VI. Rational Behavior and Design Economy
In economics or finance, only considering the future conditions make sense to the decision making. We do study the past, the purpose of collecting historical data is not looking for parallel curves to make future prediction; as we have discussed at the beginning that the market will never repeated exactly, but to discover any time invariant variables, which can be used in the decision making calculation.
Speed of money circulation and investment rate of return are two time invariant variables so far discovered by today’s thinkers and researchers. Infinite spreadsheet has demonstrated that a deterministic system can be build to help us in achieving rational behavior to stabilize the economy, which is the first step in social science.
Like we did in science, we can design our economy at any speed, just like design a car. Our government is the representative designer to control the speed of the economy.
Without a deterministic system, any assessments of the economy will be mistakes, and if this is made by the government, it will bring the disasters to the country’s economy.
Internet companies have special business character, its market went global without traditional effort, it is benefited from all existing infrastructure, therefore it has high investment rate of return by its own nature. Post Science Institute has followed the market, for the stocks, they have monitored; most of their prices were in the reasonable range as supported by their earnings at the same time. In another words, overvaluation is not detected.
The money supply retraction policy carried by Mr. Alan Greenspan has caused depression in the Internet industry by loosing the investor’s confidence and leads a chain reaction of weak earnings in high tech companies, which in turn triggered economic recession. His claim of bubbles of Internet stock market has significant impact investor’s confidence. After tremendous lost in year 2000 to 2001, none dare to believe business with greater than 50% rate of return, which has destroyed all the future high return business opportunities.
According to equation PQ = VM2, 50% growth (Q) needs about 20% money supply (M2) as V equals approximately 2.5 in United States. US government reduced money supply from 18% in Mar. 2000 to 3% in Dec. 2000. Internet companies with 15% to 50% (or higher) growth got obsolete by this governmental action.
VII. Techno Democratic Government
According to Post Science Institute, physical science deals with about five variables. Social science deals with about fifty variables, and life science deals with five hundreds variables. Human being has got great achievements in science, but social science is still in its infancy. Economics is part of social science; it is the most fundamental and easiest part. Its formats define and support the political systems.
In the past hundreds years, most western countries are experiencing free market economy, and most eastern countries are experiencing namely “planning economy”. Theoretically, both economic systems failed.
The socialism countries and their “central planning economy”, in fact, is dictatorial system limiting the planning by private citizens, therefore it cannot motivate people’s production, innovation and cannot stimulate economy growth.
The most famous slogan used by socialism is “Make your best contribution; get the best you deserve.” How to evaluate people’s contribution? How to assess everyone’s contribution is a question of price determination.
Without experiencing in free market, none is able to understand the nature of economy. Without collect data and study the relationship among all the variables in economics, none is able to reveal the restrictions, the laws of nature in economy.
The failure of capitalism is they cannot avoid cyclic market crash, and the governments in these countries have created so many man-made laws conflicting with law of nature, these man-made laws create economic disasters and human war.
With rich experience for free market, people living in capitalism countries are on the good track of gaining understanding of the nature of economy. The infinite spreadsheet is a product birthed out from this matured environment. It discovered the time and space infinity requirements in economic price determination, and this established a foundation for a decision-making system and a new format of government, the Techno Representative Government.
Under the Techno Representative Government, knowledge should have the highest power, and than are people, the government is only an executive organization to carry out the decision made by the decision system.
The function of techno representative government is to form a central controlled decision-making system, and fine-tune the free market to stabilize the economy by eliminating irrational market fluctuation and avoiding market crash and economic recession. The stabilized economy will build investor’s confidence and support new technology and any innovations. Designing is better than passively waiting for free market adjustment. With the rational methodology supported by laws of nature, the more Designing, the more the society will be benefited.
Science has no country, no racial, no political boundaries, because science is based on the laws of nature, which governs the behaviors of physical material. The goal of social science is to find laws of nature governing people’s activities, which will help us to make decisions regarding what we should do and how to do it.
Only when the stabilized economic condition achieved, the other political concerns can be considered as a special factor in the valuation system for any kind of decision-making.
