The Blue Chip Bubble Friday, Dec 23 2011 

This post is a follow-up and elaboration upon my earlier post: Risk, Profit, Wealth and the Money Flow Mistake.

In his book, Science and the Modern World, Alfred North Whitehead coins the phrase “fallacy of misplaced concreteness” to identify the instances in which we take an abstraction and treat it as more concrete than the concrete thing upon which it is an abstraction.  In science, this is done when atoms are treated as the “real” building blocks of reality and the everyday objects are considered as “mostly space,” therefore, somehow not as “real.”  This gives rise to an inherent inconsistency and paradox within science since the “reality” of the atoms can only be determined if the scientist uses the everyday tools that are later considered “unreal” such as pencils, paper, microscopes, and the like; creating the dubious claim that the reality of the atoms is a function of tools that are deemed unreal.  This inversion of concreteness has an analog in the world of finance and it concerns the idea of profit.  Let me be clear at the outset that I am not arguing against profit or against the legitimacy of making a profit; rather, I am arguing that the role that profit currently plays in finance is a role that assigns to it a position of concreteness to which it is not entitled; therefore, I argue that its proper role be reinstated.

The nature of profit has changed significantly in the modern age from something that allowed someone to “make a living” to something that is more nearly akin to robbery.  In current parlance, profit occurs only after all of a company’s financial obligations have been discharged and funding allowance has been made for research and development in order to accommodate the company’s growth.  This means that profit only occurs after all compensation has been paid.  For a sole proprietorship, this compensation is probably quite modest and flexible since dedicated business owners will forgo their own compensation in order to keep the business “alive.”  However, in the realm of “C” corporations and the like, executive compensation is decided by contract and the board of directors.  In this case, the “profit” of the company is not connected to regular compensation and only distantly to bonuses.  What this means is that what was once considered a “fair” profit, i.e., enough of a markup to allow the owner to pay his or her personal bills and “make a living,” is no longer an adequate measure since the executive “makes a living” based on pre-profit dollars, that is, executive salaries, which are the way executives “make a living,” do not come out of profits but are paid before the amount of profit is calculated; thus, by the “old” measure, not fair.  Even if it were argued that the executive is not the one that has to “make a living,” rather, it is the corporation itself that has to survive, the point still remains because “making a living,” when unpacked in terms appropriate to a corporation, simply means that it has the ability to “better its lot” in the corporate world.  However, this is done by means of research and development, which, as noted above, is funded before profit is calculated.  So, again, when profit is understood in this new modern way it stacks up as grossly unfair when compared to the older standard.  Indeed, it is precisely this insight that fuels the rage in the OWS movement.

This might be framed as the question: what is a fair profit? but to so frame it would be a red herring…and not the one that refers to the prospectus, either.  It is a red herring precisely because it leads one to adopt a line of argument against a position that is, more or less, irrelevant.  The question is not whether the profit is entirely fair or not; the question, rather, the questions, concern the source of the profit and the use to which the profit is put, since it is already taken for granted that the profit is not fair.  In this regard, I must lay the blame for any misuse of profits at the feet of the way that companies are legally organized and the source of much of that profit at the feet of the government.

As far as things stand right now, and to the best of my knowledge, businesses may legally organize in only one of two ways, either for profit or not for profit.  In either case, the company is legally bound to comply with the strictures of whatever way it has been organized.  Thus, if “for profit,” then it is legally bound to make all decisions in the best interests of the shareholders and are legally prevented from spending that money for, say, good social causes such as feeding the poor and the like.

This was made painfully clear to the owners of Ben and Jerry’s Ice Cream after they went public.  Since it was in the best interests of the shareholders, the owners were forced to accept a buyout offer from a company that they did not want to accept–a company which did not share their concern for social causes.  Accordingly, the company they founded was taken away from them and the social causes that had been the beneficiaries of their generosity suffered.  As a result of this case, a movement has begun to allow for a different way to legally organize a business, “for benefit,” so that the “excess” money made by a company can be funneled to the social causes identified within their organizational papers or charter.

Still, this does not address, perhaps, one of the most egregious aspects of profit and that is the source of the “profit” that is provided to a company by taxpayer monies.  This comes about because the ability to tax is also the ability to promote or prohibit any particular corporate behavior; for instance, to promote a certain behavior the government gives it a “tax advantage” and to prohibit any particular behavior, the government simply increases taxes on that behavior.  As a result, behaviors that are “tax advantaged” are indulged in “for free” by corporations, since they receive a tax benefit for indulging in them.  Take, for example, the fact that government wants to encourage certain business practices and, as a result, allows business to “write off” the cost of those practices.  In effect, the business is reimbursed for those expenses which means that instead of using the money it earns to pay for those expenses, the same amount, taken from what it earns, can be channeled into other areas of the company, usually executive compensation.

The implications of this include the unavoidable conclusion that what has passed for “earnings” in the corporate world is nothing but the redistribution of tax dollars and not earnings at all.  Unless a company can meet all its obligations without tax relief from the government, then it is not profitable; and if it is not profitable, it should close its doors.  However, let me draw upon a broader wisdom to add that if it is not making enough money, then it is because it is not giving enough and should reorganize as a “for benefit” company.

I began by citing Whitehead’s phrase “fallacy of misplaced concreteness” as a way of highlighting what I think has gone awry with our understanding of “profit” and now I would like to return to the concept of “misplaced concreteness” to tie everything up.  “Business as usual” means that we charge “what the market will bear” for goods and services; or, to put it another way, the cost of production has little, if anything, to do with the amount charged the public.  This strategy is usually defended by appealing to “the law of supply and demand,” which states that the price varies with the demand.  This might seem perfectly reasonable until we realize that the corporations themselves control supply, thereby, controlling price.  The American Medical Association has complete control over how many students are admitted into medical school each year, thus, controlling the “scarcity” of doctors and supporting the hefty fees that can be charged once the students get their degree.  In manufacturing, the manufacturer simply stops producing so as to keep supply limited, thus, keeping the price high.  In the service arena, the provider pads the costs of labor to be offer justification for price increases.  As I mentioned above, I am not arguing against either making a profit or the legitimacy of profiting; I am arguing against the fact that profit, per se, has insinuated itself into a position of concreteness where it does not belong.

This “misplaced concreteness” is illustrated by the fact that every decision in business is made by determining whether the chosen course will “make a profit.”  Remember, “profit” only comes after all other financial obligations are met; all the workers and executives are “making a living” and the corporation, itself, has provided for its future growth and development.  It is this centrality of profit in the deliberations of corporate strategy that is misplaced concreteness because, as with the paradox in science, it treats profit as more valuable than what produces it.  Additionally, it demands that “what the market will bear” is the final arbiter in determining the price paid by the consumer.  Although this outlines the common practice, as I mentioned in my previous post, this is self-destructive because it treats the business and consumer as essentially fragments of the economy, such that, the behavior of either one has no affect upon the other.

The real locus of concreteness is the whole economy and not any particular participant or group of participants; thus, each participant has the obligation to evaluate every transaction on the basis of whether it will advance the economy as a whole or not.  Each participant can get a general sense of what is needed by evaluating the gap between the most advantaged individual in the society and the least advantaged individual in society; the narrower the gap, the more balanced and healthy the economy because the widening of the gap means that there is a blockage to the flow of capital in the economy, thus, destructive to the economy.

Let me briefly say a word to those who are members of the corporate “elite” in this country: the health of the economy is not about you and how wealthy you are; it’s about how wealthy we all are as a nation; and as long as there is even one person living in poverty, you lose.


Risk, Profit, Wealth, and the Money Flow Mistake Friday, Dec 16 2011 

There is a glaring error that lies behind both the political intransigence and the economic collapse; it is what I call “the money flow mistake.”  This mistake consists in the failure by both business and government (and their respective champions in congress) to recognize the source of their money and the holistic nature of the economy.  The source of money for each of them is the public.  Although both business and government are dimly aware of this source, it has not been made sufficiently explicit for either of them so as to enable them to draw the inference necessary to maintain a stable relationship with each other within the context of the overall economy.  This error is further compounded by the fact that their failure to see the holistic nature of the economy gives rise to a jaundiced understanding of  economic profit/growth that carries the seed of its own destruction within it.

Business depends on the public as a source of money as it plies its goods and services; and government depends on the public as a tax base to fund projects that are deemed “in the common good.”  Neither of them sees that there is an inverse relationship between, on the one hand, the price of goods and services charged by business/taxes levied by government and, on the other, the overall health of the economy because each fails to see that the economy is a whole that includes business, public, and the government such that the behavior of any one or group of these affects the entire economy.  What this means is that neither business nor government recognizes that higher prices charged by business has the exact same affect on the economy as do higher taxes levied by the government; that is, “profit,” as currently understood by business, strangles the economy as much as taxes do.  This seems counter-intuitive to business because it understands the increase of profit as good for business and counter-intuitive to government because it sees increased taxes as growth.

“The Economy” is a phrase that we use when we want to talk about the activity of exchange within a community or society.  If that community or society has adopted a common medium of exchange, i.e., legal tender, then the conversation about “the economy” is really  a conversation about the flow of that common medium; in our case, the common medium is dollars. Since the supply of dollars is controlled by the government, then it should be clear that the more dollars that are held and not flowing, the less dollars there are in the economy to flow.

When we speak about our economy growing, what we mean is that the flow of money between participants is increasing in amount, velocity, or both; similarly, when it is not growing, or in recession, we mean that the flow, in either amount or velocity, has decreased or halted altogether. So, in simplistic terms, if the flow of money is blocked, the economy begins to slow down; unless that blockage is removed, the economy slows down until it falters and fails.  Of course, the main question we want to ask is: what blocks the flow of money?

For any given moment in time there is a definite and finite amount of money in circulation; for that period of time it should be clear that if some of the money is held away from the flow by participants, then there is less money to flow to the other participants in that moment.  The cash that is “on the sidelines” is the very reason that the economy is stalled because, if it is “on the sidelines,” then it is not “in the flow,” which is why we say that it is “on the sidelines.”  And if it is not “in the flow,” then it is cash that has been taken away from the smooth working of the economy, hence, damaging it. It is at this point that we must examine our notion of “wealth.”

Unfortunately, our notion of wealth is a notion that is nearly synonymous with “having.”  That is, we consider an individual or company to be wealthy just in cases where that individual or company has alot of money.  However, those who truly understand wealth realize that their financial statement of net worth is merely a snapshot of activity and that their wealth consists in the using of capital and not in the mere having of it.  This is an important point to understand because under our economic premises, profit is the reward for taking risk, and taking risk means using capital with no assurance that you will get it back.  However, when companies get to a certain stage of growth, the risk that they take nearly dwindles to nothing and they become more concerned with preservation, that is, preservation of cash, market share, etc.; and it is this shift in thinking that is threatening to the overall economy.

This shift in thinking arises from a faulty model of how the economy works–a model in which money is analogous to food in the human body.  On this model, as food (money) is consumed the body grows and one must always have a freezer to store food against “hard times.”  Accordingly, corporations hold tremendous amounts of cash “in reserve” and as “stockholder’s equity” on the balance sheet.  However, the role that money plays in the economy is more accurately represented by blood in the body.  It is because the blood carries the nutrients to the parts of the body that the body grows; the body doesn’t grow just because you have a full freezer and pantry.  But, more importantly, the salient difference between these two understandings of the role of money is that blood circulates within the body and food is processed out of the body; and unless blood does flow, the body will die.  So, the life of the economy is not in the having of money, it is in the flow of money.

Unless business and government are able to see that the health of the economic situation of individuals, companies, and the nation consists in the flow of money, they will not see that stockpiling it is killing the individual, company, and nation.  In the recent activity of quantitative easing, the idea was correct but misplaced; since both business and government look to the public for money, the quantitative easing should have been directly assigned to the public.  This could have been done by forgiving loans that were guaranteed by the government (housing and student loans, for example) and the payments that would have gone to those loans would have immediately found their way back into the flow of the economy.  Instead, the money was given to those who had cash in reserve but who were/are unwilling to take risk by hiring in the face of an apparent lack of demand while still justifying their own profits although no risk was taken.  This shows up the inherent fallacy of “trickle down” economics since that view supposes that business/government does not need the public and that money is for their own exclusive and private use.  This view is also the source of the recent claims of “class warfare” because it explicitly identifies the wealthy as the source of the droppings meant for the public.

It should be clear that “growth” in the economy, as well as its “health,” is not a function of how much money any particular individual or group of participants in the economy has but in the number of people participating in the flow of money.  Since any individual or company can only thrive in a whole economy, it is in every participant’s best interest to see that there are more and more participants.  In many respects, the economy is like a three-legged stool; if any leg is too long or too short, it will fall over; and the secret to stability is to realize that lengthening any one leg will shorten the other two.  I haven’t considered the case where the public has all the money, but it should be clear that no business could survive if no one spent anything; nor could we provide for the “common good” if no taxes were paid.

As things currently stand, business and government are the “long legs,” the public has but a nub, and the stool has fallen over.

There is another aspect to this problem that I will deal with in another post and it has to do with the fact that the options businesses have for legal organization dictate how that business uses its cash.

The Legend of the Wissahickon Sunday, Dec 4 2011 

The original author and publisher are unknown.
Taken from the Library of Congress, Washington, D.C.,
by Guy W. Ballard in the early 1930’s.

Near Philadelphia, on the banks of the lovely Wissahikon River, there was once a Protestant monastery where lived a brotherhood of noble men who had left Europe and sought a home in the wilderness where they might worship God in their own way, far from the courts of kings. They were known as Fanatics.

About one mile from the old monastery, there lived a man who was of the brotherhood in belief, but not with them because he had brought with him to the new world his young son and baby daughter. He was a nobleman of wealth and position, whose religious beliefs were tolerated neither by Protestants nor Catholics. He had lived patiently and quietly in the Old World doing his best and faithfully serving his king, until his beloved wife died. Then he had given up his castle, his lands, his title and most of his great possessions, and fled across the sea with his young son and baby daughter, to make a home in an old time blockhouse of the Wissahikon wilderness. There he lived and studied the book of Revelations for seventeen years. Meantime his little son became a noble youth who shared in his father’s every hope and conviction; his baby daughter became a fair maiden, lovely beyond words; with gold hair which fell not in ringlets nor curls, but in soft, wavy profusion to her shoulders.

We are told that when the shadows were beginning to lengthen on the last day of 1773, the little family might have been seen walking arm in arm along the banks of the Wissahikon, beneath trees bending under their weight of snow. The father, who was then known and loved far and near as the Priest of the Wissahikon, wore a velvet cloak with a silver cross suspended by a cord around his neck. The girl, with a look of adoration upon her face, listened without questioning to the conversation between father and brother in whose eyes shone the light of immortality. For seventeen years the old man had studied Revelations and again he repeated what he had affirmed so many times before, as the result of these years of study.

“The Old World,” said he, “is sunk in all manner of crime, as was the Antediluvian World; the New World is given to man as a refuge, even as the ark was given to Noah and his children.

“The New World is the last altar of human freedom left on the surface of the globe. Never shall the footsteps of Kings pollute its soil. It is the last hope of man. God has spoken and it is so. Amen.”

It was the girl who urged a return to the house, and it was she who sought its warmth and shelter for the sake of her loved ones, and drew the curtains at the windows of the living room to shut out the gloomy forest and coming night. It was the girl who tried to bring cleer to the little group and to lighten the sadness of her father and brother; to distract them from their somber thought and study. That night she tried in vain; she knew that passing hunters again would hear the voice of prayer late into the night, and see the chapel lights streaming across the snow until the dawn.

The hour of separation came when father and son bade the maiden good night and together sought the chapel where two tall candles were already burning on the white altar. It was a circular chamber with oak panels. Between the candles on the altar was a slender silver flagon, a wreath of laurel, freshly gathered from the Wissahikon hills, and a velvet bound Bible with clasps of gold. Behind the altar was an iron cross. The Priest of the Wissahikon was the first to break the silence.

Said he: “At the third hour after midnight, the Deliverer will come!”

Then as the young man stood pondering, the father responded, “Tonight he will come. At the third hour after midnight he will come through yonder door and take upon himself his great mission to free the New World from the yoke of the Tyrants. All is ready for his coming. Behold the crown, the flagon of anointing oil, the Bible and the Cross!”

Hours passed. The lad knelt in prayer; but the father paced up and down the chapel waiting until the clock of the great hall struck twelve and the New Year dawned. Then the lad arose and gently tried to prepare his father for disappointment. Perhaps they were mistaken; perhaps they were not right in believing that the time for the deliverer was at hand.

“At the third hour after midnight the Deliverer will cone!” was the father’s answer.

The lad returned to his prayers and the Priest of the Wissahikon continued his lonely watch while the clock struck one, two, three. Then there came footsteps in the hall, and a tall stranger of commanding presence entered the door of the chapel and spoke these words:

“Friends, I have lost my way in the forest. Can you direct me to the right Way?”

Answered the Priest of the Wissahikon, “Thou hast found the way to usefulness and immortal renown!”

Wondering, the stranger came a step nearer to see if he were being mocked; but the Priest of the Wissahikon rapidly questioned him. Did he come from the city? Yes. What was the burden upon his heart; was it not his country’s welfare? Yes. Was he not troubled about the right of a subject to raise his hand against his King? Yes! Then said the Priest of the Wissahikon to the amazed stranger:

“Thou art called to a great work Kneel before this altar and here, in the silence of the night, amid the depths of these wild woods, will I anoint Thee, Deliverer of this great land!”

Immediately this peerless stranger before whom ten thousand might bow their heads, knelt before the white altar in the old blockhouse and placed his hands on the Bible.

Then, says the legend, these words fell from the lips of the Priest of the Wissahikon:

“Then art called to the great work of a Champion and Deliverer! Soon thou wilt ride to the battle at the head of legions – soon thou wilt lead a people on to Freedom – soon thy sword will glean like a meteor over the ranks of war!”

The candle light cast weird shadows on the wall, the silver cross of the Priest shone, the white altar cloth waved in the wind from the open outer door, the trees moaned outside, while the Priest, so the story goes, continued thus:

“Dost thou promise that when the appointed time arrives, thou wilt be found ready, sword in hand, to fight for thy Country and thy God?”

Solemnly came the answer, “I do!”

“Dost thou promise in the hour of thy glory, when a nation shall bow before thee, as in the fierce moment when thou shalt behold thy soldiers starving for want of bread, to remember the great truth written in these Words, ‘I am but the minister of God in this great work of a Nation’s freedom’?”

Clearly, firmly, came the answer, “I do promise!”

“Then in His name who gave the New World to millions of the human race, as the last altar of their rights, I do consecrate thee its Deliverer!”

The Priest of the Wissahikon dipped his fingers in the anointing oil and described the outlines of a cross upon the stranger’s forehead and was about to place the laurel wreath upon his head after saying: “When the time comes, go forth to victory. On thy brow no conqueror’s blood-red wreath, but this crown of fadeless laurel,” when the girl appeared, took the wreath and crowned the stranger.

Unable to sleep, she had hastily donned a white robe, and putting a dark cloak around her, had gone down to the chapel and had witnessed the scene unnoticed until she had seized the laurel crown from her father’s hands. Fearing she had been presumptuous, the girl bowed her head; but the father smiled.

“It is well,” said he, “from whom should the Deliverer of a Nation receive his crown of laurel, but from the hands of a stainless woman.”

Then spoke the lad: “Rise, the Champion Leader of a People. Rise, sir, and take this hand which never yet was given to man. I know not thy name, yet on this Book I swear to be faithful to thee even to the death.” Then Paul, for that was his name, buckled a sword to the Stranger’s side.

When the ceremony was over, the stranger stood in the chapel in towering strength and majesty and said these final words:

“From you, old man, I take the vow. From you, fair girl, the laurel. From you, brave friend, the sword. On this Book I swear to be faithful unto all!”

A moment later the stranger vanished into the outer wilderness of the Wissahikon and the sound of his retreating footsteps mingled with the moaning of the wind. That was New Year’s Night of the year 1774. In the darkest hour of the American Revolution; the blockhouse was burned; and while smoke still rose from the ruined home, three were sleeping in their graves by the Wissahikon; one was an aged nobleman; one was a fearless lad; and the other, a fair girl with a wealth of golden hair.

Years later, when America was a nation, and George Washington was her President, again came the stranger of noble presence to the banks of the Wissahikon, seeking the blockhouse and the three who sent him on his mission that New Year’s Eve of 1774. He found the ruined blockhouse and the graves. That night, at a party in the bright city of Philadelphia there were many who wondered why, at a time when a nation bowed before him, the Father of our Country was sad and thoughtful, and bowed his head as if in memory of grief when a fair maid, with a wealth of golden hair, sang a song of the Wissahikon.