Economic Equilibrium – Theoretical Error

Written by Carlos Bondone

The macroeconomics in effect (with nuances between the different currents) finds theoretical sustenance in the idea that the economic variables must strike a balance, as the aim for the diagnosis and treatment of economic life.

Since equilibrium theories in force have not been satisfactory in explaining-solving the real economic problems (currency crisis, cycles, etc.), it is necessary to review them.

The Theory of Economic Relativity (TER) presents an approach that is completely different from the concept of economy tending towards equilibrium. So different it is, to the point of concluding that we should better state that the best progress for human economy -both individual and collective— is in fact to achieve a state of increasing imbalance. For this purpose, the central theoretical foundations of the TER are summarized here; those that sustain what could be called “disequilibrium for growth”.

The Equilibrium Solution: this is how I have named, within the work Theory of Economic Relativity, the diagnosis that Keynes made in his General Theory: A scheme that tries to balance the real world and currency or virtual world, individually and altogether. (Theory of Economic Relativity – page 362 – Spanish edition).

In terms of the current theories, the requisites or foundations to achieve such equilibrium follow hereunder:

  1. S = I (Saving = Investment)
  2. Currency vs. Real interest rate (i); and Real vs. Currency prices (p).
  3. Competition tends to equalize profits, known as Classical Adjustment.

Let’s see briefly how each of these theoretical foundations fall apart:

1) If we considered S as the set of the economic goods produced since the appearance of human beings in the Universe, and not consumed (as current economy would treat it), we conclude that S equals the assets of the community (which is, at the same time, the aggregate of the assets from all the economic agents). From this it follows that:

S = C + A + M + Cr + H + I = L + NW

Note: S (savings); C (consumer goods); A (Available funds); M (merchandises); Cr (credits), H (preventive-speculative hoarding); I (investment – capital); L (liabilities) and NW (net worth).

It is evident that, when considering society as a set, we can cancel from the preceding equation the elements Cr and L for being always equal (the credits of some agents are the debts of others). Thus we have:

S = C + A + M + H + I = NW

This simple conclusion allows us to deduce that economy’s state is always in an imbalance or disequilibrium -in regard to the concept of equilibrium sustained by the present theories- since, instead of S = I as it is postulated, the truth is that by axiom (ex ante and ex post) the condition which always occurs is:

S ≠ I

And this is it because in the previous equation it is impossible that C + A + M + H = 0 at any given time and place. Otherwise we would be talking about a man without life (who, at least, does not consume).

This (accounting) equation is the one I call total wealth equation (in the TER), where the concepts of hoarding, saving, liquidity (A), investment, etc. form the set economic wealth, the inverse treatment to what comes up from the present theories that allow (mistaken) concepts like “exogenous”, “variable’s neutrality…” and others, as if they acted affecting the economy from the outside, like “independent variables” (investment and/or autonomous expense, etc.).

2) The TER tells us that economic time is the economic good that does not have a life of its own, that is always materialized, inevitably, in another present economic good, and that its price is the interest. When economic time is exchanged interpersonally, credit is configured. On the other hand, we know (also for the TER) that in the current financial systems, currency is represented by credit (not by money: currency in the form of present economic good), credit which is irregular as well -a situation not necessary for this analysis, yet relevant in that of the redistribution of wealth.

Like colophon of the preceding paragraphs, we conclude that in the current financial systems, being currency a credit, whose price is the interest (i) , and the prices’ level (p) considered are those expressed in currency terms, it can be concluded by axiom (ex ante and ex post) that:

i ≡ p

This equation puts an end to all the (mathematical and chart) models that postulate i and in different coordinates, like different variables, when in fact they are a same entity. The reader will notice that the macroeconomic currency models used for the diagnosis and treatment of the economic crises fall apart. Because this new theory shows us the reason for the lack of consistency in the economic predictions that they are made based on equilibrium theories.

But this equation has in addition a very special connotation: it evidences that what is known as currency policy (to regulate the interest rate in accordance to inflation, growth and unemployment) is, in fact, a price control policy, no less than a control over the good that is used in exchanges and economic calculations.

In other words, in the current financial systems the currency policy is the most powerful system of price control, concealed by the theoretical error underneath the idea that what is being controlled is the interest rate level, thus circumscribing the problem to the financial sphere alone.

In order to finish this item, it is only due to mention that the raising in the level of prices (called inflation), originated in irregular currency systems (like the ones in effect), is just one “deficient” statistical measurement of the (authoritarian) appropriation of economic time by the State, in detriment of the citizens.

3) Another way to express the concept of equilibrium is what is called “classical adjustment”, which states that competition tends to equalize profit rates. But then, with the TER, it is postulated that the action of the businessman is intended to surpass his peers in profits, like in all competition. Therefore, it follows that the best formula for economic growth is once again disequilibrium, this is: to surpass the present records.

From what was explained above we conclude that: “welcome the profits” (which is sustained in individual freedom, which means “to create wealth” ); and “ill natured” the irregular financial systems (authoritarian systems), which are the main source of the unfairness in its distribution.

To sum up, the TER postulates that natural order, to which the concept of “spontaneous” can well be added (Menger – Hayek), is the best path for a peaceful economic development, i.e.: wealth growth (by fortifying the institutions of individual freedom) in fairness (erasing the “unequalizing” authoritarianism underlying the financial systems in force).

Buenos Aires, December 2007.  


Translator Note: The distinction between money and currency is essential in this work. The author places the term “currency” as a more general categorization than that implied in “money”. Thus, currency can acquire whether the form of money or of credit, and this last can be regular or irregular.

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