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Money Flows

This is a more complete discussion of how money flows through the economy, than we could cover within The WelderDestiny Compass newsletter. It is part of a wider discussion to predict if we are headed to a utopian or dystopian future. You can read the complete edition #005 of The WelderDestiny Compass e-zine by clicking here...

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Money Flows Through The Economy

For the last couple of decades, the concept of “trickledown economics” has received a lot of air time in the media. The idea being that if we create rich people within our economies, then their wealth will “trickle down” to the middle and lower socio-economic classes. This suggests that money flows from the wealthy to the middle and lower socio-economic classes.

A little logical thinking makes us understand that economies have never worked that way, and logically cannot work that way if it is to be a long term sustainable structure.

Let us look at this by considering a system that was largely a barter economy rather than a money economy. Under the feudal system there were land barons that allowed subsistence farmers to farm on their land, in exchange for a share of their harvests. The land barons paid “tribute” to the local kings to keep them in charge of the land. We can see that this is a “trickle-up” model. The value is added at the bottom, and this value is concentrated up the socio-economic pyramid.

Money flows in a modern business is very much the same. The business owners hire people to add value and therefore “bring in the money”. The value is created by the employees. The business owners take a share of what each person adds in value and that goes into the businesses’ coffers. From this process both employees and business owners pay taxes to ensure that they are protected from those people that may want to upset this apple cart. This means that taxes are primarily meant for policing and military activities.

We can see that money flows from the base of the socio-economic pyramid upwards. It takes many people in the lower socio-economic classes to support somebody at the top. It cannot possibly work the other way around. Why would anybody make a lot of money through their own efforts, (a rich person in other words) and then pay this down the pyramid to people that add no value to the process? Such a system is obviously not sustainable, as it is working against human nature. This is why the communist systems have failed, or morphed into quasi free market systems. The theory supporting communism may sound great, but it is “out of step” with human nature.

So, if money flows up the socio-economic pyramid, then eventually a small percentage of people will end up with all the money in their bank accounts, and those of us at the bottom will have no money to actually buy stuff with, regardless of how much money the system starts off with, and regardless how much value we add at the bottom of the pyramid. Clearly there needs to be another flow of money that “recycles” the money to the bottom of the pyramid again.

Well, if we think of it, how do the wealthy people keep their wealth? Do they all have huge safes in their homes where they store their billions of dollars? No, most “wealth” of the wealthy is captured in some kind of investment asset. As an example, Bill Gates is worth around $85 billion. Of that, around $14 billion is in Microsoft stock with the remainder invested in other businesses and real estate, including a number of islands (Go Bill!). Bill Gates also owns quite a lot of collectables such as art works and even rare automobiles. I could not find how much he keeps in “ready cash”, but it will be a very small percentage of his total wealth. As a percentage of their net-worth, rich people keep less cash than most middle-class people.

In other words, wealthy people actually buy assets with their money, which feeds the money back into the system. Their wealth is expressed in money terms, but they do not actually have that much money. This means that the money is in fact available for “circulation” within the economy. The rich people are not “hogging the money”. They are “hogging the assets” that represent wealth. In general, the assets they are spending their money on are assets that can generate an income, or that will grow in value over time. Typically land and businesses and collectibles.

We have previously discussed how value can be created without money being added to the system. A business can increase greatly in value, and then be sold to investors, including the rather wealthy people we are talking about. As an example, Microsoft grew by a factor of 666 times between 1986 at its initial public offer (IPO), to December 1999, when it was at its peak. Now, keeping in mind that Bill Gates started up Microsoft from “scratch”, the initial value when he started it, would have been zero. That is a lot of value added!

In short, Bill Gates got wealthy by growing his business. This business is now part of the wealth of other rich people (and middle class) who would have also invested in Microsoft stocks at some point. Operating and growing businesses is one way of “pumping” money from the top of the socio-economic pyramid, to levels lower down. In particular, the people with jobs in the companies are the last step in moving the money down to the bottom of the socio-economic pyramid.

The problem is that when most “jobs” in big business have been replaced by machines, then the power of jobs to pump money to the bottom of the pyramid loses its prominence . The only solution is that people lower on the socio-economic pyramid are forced to become “solopreneurs”. In the future, you will need to own your own job, rather than relying on a single employer to look after you.

As long as this system is left to itself to operate in a free market system, it tends to be self-sustaining and relatively robust. Unfortunately there are always people that think that they should intervene in the system. Sometimes out of misplaced ideological motivations, but mostly to try to get some advantage for themselves at the expense of others. This tends to skew the system  and create situations that make it difficult for people on the lower ends of the socio-economic ladder to pull themselves up, or results in the transfer of wealth from one group to another. This is the good old self-interest that we discussed previously. This is where it is important for everyone to make sure that the “rules and regulations” on small businesses are as limited as possible, so that the friction in creating and growing businesses are minimised.

At any rate, the economist Vilfredo Pareto discovered that 80% of wealth tends to end up in the hands of 20% of the population. This is more broadly known as the Pareto principle. This ratio tends to skew one way or the other, depending on how economies are manipulated, but that is pretty much where it ends up. This Pareto principle is not just an economic occurrence. It is inherent in many statistical distributions. If we are not part of the 20% holding most of the wealth, we may feel that this is not fair. Understanding statistics and human nature will however make us accept that this is just a fact of life and statistics.

Understand that by definition everyone cannot have above average wealth, but we should all have the opportunity to pursue our own dreams in life. Such dreams may not necessarily include above average wealth, but will in all probability necessitate that we can not be reliant on an organization to look after us.

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