Money, credit, interest, and debt have been examined in earlier chapters. In this chapter, National Income will be examined to ascertain how the production of National Income is complemented or insulted by the flow of money, credit, interest and debt.
When skilled labor produces raw materials for the first point of sale, jobs and incomes are created that consolidate into the basic industries of agriculture, forestry, fishing, mining, and recycling. Development of these raw materials into finished goods by manufacturing creates service jobs in transportation, utilities, finance, wholesale & retail trade, etc. The total enterprise accumulates as National Income.
Raw materials are a fundamental component of National Income accumulation because these materials are the source of metabolic and kinetic energy (food and machine energy). Society exchanges and prices this energy at every stage of production, distribution and consumption. This creates National Income.
If a society is to maintain cohesiveness for future generations, the production and consumption of raw materials must expand. The National Income must grow as the population expands, or the nation will deteriorate.
National Income is the total amount of incomes that Americans earn as they pay each other in the course of producing goods and services during any calendar year. In 1993, the National Income totaled about 5.1 Trillion Dollars. National Income can be displayed as an inverted pyramid with raw materials at the bottom and consumers at the top.
The National Income is defined by the Department of Commerce as the income that originates from production. However, since the American economy is driven primarily by debt expansion, National Income can also be considered as the income that originates from production and debt expansion.
The term "National Income" should not be confused with "Gross Domestic Product," the "leading series" that the Department of Commerce publishes, and the series that economists, government officials, and media use to monitor growth. GDP is defined as the market value of goods and services produced by the labor and property located in the United States.
GDP is calculated by combining National Income with the consumption of fixed capital, (depreciation), indirect business tax and non income tax liability. This results in a total approximating either GDP (Gross Domestic Product) or GNP (Gross National Product).
In 1991 the government changed the lead series from GNP to GDP, but the difference between GDP and GNP is insignificant. Here is the difference. Gross National Product (GNP) and Gross Domestic Product (GDP) are similarly defined in terms of goods and services produced, but they use different criteria for coverage.
GDP covers the goods and services produced by labor and property located IN the United States. As long as the labor and property are located in the United States, the suppliers (that is, the workers and the owners) may be U.S. residents or residents of the rest of the world.
GNP covers the goods and services produced by labor and property SUPPLIED by U.S. residents. As long as the labor and property are supplied by U.S. residents, they may be located in the United States or abroad.
However, since National Income measures production, and since this text focuses on U.S. production and essential services associated with production, National Income will be used as the lead series throughout this publication.
IDENTIFYING THE SEGMENTS OF NATIONAL INCOME
The United States Department of Commerce separates jobs and business into different "sectors" so the economic health of a particular area of endeavor can be monitored. These economic sectors are condensed into only five segments which, since the early part of the 20th century, have provided an overview of America's general economic condition. A review and analysis of these five basic segments are a pre-requisite for understanding the mechanisms that govern economic growth.
These five segments are:
(1) Proprietor's Income, both farm and non-farm,
(2) Corporate Profits Before Taxes,
(3) Rental Income of Persons,
(4) Wages, Salaries & Supplements and,
(5) Net Interest.
Analyzing these segments of National Income and the profits and savings that flow from the first three segments, are necessary to accurately predict periods of prosperity, stagnation, recession and depression.
Natural relationships should exist between each segment of National Income. These relationships can be calculated as ratios and can be predetermined within the discipline of Raw Materials Economics. By forecasting these ratios, one can pre-determine overall levels of profit and cost, that together accumulate as National Income. Sometimes these ratios predict economic prosperity, and when altered, they predict recessions.
Changes in technology and public policies alter the ratios between these 5 segments of National Income and the ratio of each segment to total National Income. The maintenance of optimal ratios create an economic generator and the maintenance of improper ratios create an economic braking mechanism.
The ratios or relationships between individual segments of National Income have no meaning at first glance and are often ignored by government economists and business.
The discipline of Raw Materials Economics employs math to establish "normal" or natural ratios between each segment of the economy and National Income. These normal ratios are based upon technology and population, and identify the proper size of each economic segment.
THE NATIONAL INCOME T-CHART
Analyzing the production income (profit) and production cost (expense) segments of the American economy in terms of overall ratios must begin by re-creating many years of National Income on a historical National Income "T-chart" using the 5 segments of National Income. This historical T-chart is continuously compiled and updated by the Department of Commerce and reproduced annually in the Economic Report of the President.
The Economic Report of the President contains a variety of information about National Income. It is a compilation of various annual statistical publications that reorganize and simplify data for the President and Congress.
The Economic Report of the President is released to the public when the President delivers the annual "State of the Union Address." The Economic Report of the President is prepared by the "President's Council of Economic Advisors."
DEFINING THE SEGMENTS OF NATIONAL INCOME THAT COMPRISE THE PROFITS OF PRIVATE ENTERPRISE
On the left side of the T-chart 19 are the "income related" or profit producing segments of National Income. Their definitions are found in "National Income and Product Accounts" (NIPA book), published each year by the Bureau of Economic Analysis, a division of the U.S. Department of Commerce. The following definitions pertain to the profit segments of the private enterprise system.
1) Proprietors Income, includes all unincorporated farm and non-farm businesses such as mom and pop operations, partnerships, cooperatives, and other persons, rich or poor, who do business without incorporating their companies.
2) Rental Income, includes all landlords' income, the income from patents and copyrights, plus royalty revenues from rights to natural resources.
3) Corporate Profits includes the profit before taxes of all corporations from the largest publicly held corporations to the smallest private corporations. Together these three segments of National Income comprise "THE PROFITS OF PRIVATE ENTERPRISE."
DEFINING THE SEGMENTS OF NATIONAL INCOME THAT COMPRISE THE PRIMARY COST FACTORS WITHIN PRIVATE ENTERPRISE
All "cost" segments of National Income are consolidated on the right side of the T-chart 19. These are incomes derived from the expenses paid by private enterprise in production related endeavors. These expenses are the main costs that relate to the 3 profit segments. They include:
4) Wages, Salaries & Supplements to Wages. The definition of wages, salaries are self explanatory. The Definition of "Supplements to Wages and Salaries" is described in the publication (NIPA) and basically consists of all employer contributions to labor.
5) Net Interest is defined in the NIPA publication as the interest paid by business less interest received by business, plus interest received from the rest of the world less interest paid to the rest of the world. Interest payments on mortgages and home improvement loans are counted as interest paid by business because home ownership is treated like a business in NIPA, as is monetary interest, which is paid by corporate financial business, life insurance carriers, pension plans, financial intermediaries etc.
These five segments add up to National Income.
These individual segments of National Income and the completed T-chart 19 are reprinted here as published in the "Economic Report of the President" and in the "National Income and Product Accounts." T-Chart 19 shows the actual ratio for each year between the profit and cost sides of the National Income.
T-Chart 20 offers a "helicopter audit" of National Income by comparing the profits of private enterprise to the income derived from costs associated with the private enterprise system.
To understand the information, review both the profit and cost sides of National Income through a historical perspective and identify years when "ratios" of profit to cost resulted in either prosperity, stagnation, recessions or depressions.
T-Chart 20 describes a National Income that has grown by an average of 2.51% per year (calculated in 1987 constant dollars since 1929). This growth should have generated consistent prosperity, but instead, it was a measure of numerous boom and bust cycles and a recent decline in profitability. In fact, the profits of private enterprise, when calculated as a percentage of National Income have declined since 1952 by approximately 1/2 from over 30% of National Income to an average of 16% of National Income during the 1980-1993 period, proving that all increases to National Income have been the result of higher percentages of cost, which release less profits each year.
DEPRESSION LEVEL PROFITS
The percentage of profitability (the profits of private enterprise) has dropped to levels of the "Great Depression." In 1932 & 1933 the profits of private enterprise totaled 17.1% of National Income. In 1991, 1992 & 1993 they averaged 16.9% of National Income.
Today, profitability is falling to a non-sustainable level because the new incomes born as metabolic and kinetic energy are too low! This becomes clear when National Income is converted into constant 1987 dollars on T-chart 20 as a method to remove inflation and better quantify growth. It proves that increases to National Income are additional "cost" and the private enterprise system has earned less and less profits each year as a total percentage of National Income.
THE ECONOMIC PIE
The five segments of National Income can be displayed as a pie chart, so the profitability of the economy during a specific year becomes more expressive. These Pie Charts are yearly representations of National Income which separate profit and costs factors.
The Pie Charts illustrate a fluctuating level of profitability throughout the 20th century, but the long term trend is down because a growing percentage of National Income is used to pay wages, salaries, supplements, and interest each year. This results in less residual income in the form of profits for private enterprise and more consolidation of property and business ownership.
This situation does not justify wage cuts by business to increase profits. Instead, it describes a National Income that's too small for current technology and population. If National Income were restored to an appropriate standard, the five segments of National Income would re-balance by increasing profits at the expense of Net Interest.
However, wages, salaries and supplements as a percentage of National Income would not decrease if National Income were restored and accurately apportioned. Instead, interest would gradually disappear from the right side of the T-chart and re-appear on the left side as earned income within the profits of private enterprise. This will raise efficiency and total National Income.
During periods of prosperity, the overall ratios of cost to profit approximated 2 to 1. In other words, the economy paid out two parts cost in the form of wages, salaries, supplements, and interest, - and retained one part profit, (before taxes) in the form of proprietor's income, rental income, and corporate profits. These periods are accurate standards that can be used as "base periods," and include the years 1910 through 1914, 1925 through 1929 and 1946 through 1950. During these base periods, profits totaled about 1/3 of National Income before taxes. During periods of depressions, recessions, or low growth, imbalances between the 5 segments of the economic pie developed which caused the overall profitability of America to suffer.
This is illustrated with the Pie Charts. During 1939, 1959, 1979, and 1993, profit was low, at 5 parts cost to 1 part profit. Profitability during the base periods of 1910-14, 1925-29 and 1946-50 was normal at 2 parts cost to 1 part profit.
The years of 1910-14, 1925-29 or 1946-50 can all be used as base periods. To avoid the connection to a war economy, 1947-49 should be used. This period was sufficiently removed from WWII, and for ten years, the Department of Commerce used 1947-49 as a standard for productivity and prices. Therefore, price and productivity increases can be measured against this standard.
Comparing prices and output to a fixed standard has been abused since the early 1960's, when the government established a new and imbalanced base period. Re-indexing the economy to an invalid base period appears to re-balance the economy on paper. Instead, it transforms an imbalanced period into the new standard. This creates a false standard and a recipe for future economic problems.
There is nothing magical about a National Income that's comprised of 2 parts cost to 1 part profit. However, this ratio is a predictable result of a much more fundamental factor which is the maintenance of a natural balance between all five segments of the nation's economy.
A balance or equity of exchange must be maintained between the price of raw materials at the first point of sale and the price of the finished goods at retail. This will maximize reciprocal markets throughout manufacturing and distribution while paying all domestic labor costs together with a reasonable return for entrepreneurial effort.
These prices are quantifiable because they reflect total energy expended, state of the arts technology, and the population base served. These prices produce accurate percentages of National Income for each of the five segments. If this balance is destroyed, debt must be created to move products and services through the economy. This balance is necessary to optimize the debt free consumption of finished goods and services. History demonstrates that high levels of debt free consumption occur when the National Income functions at a ratio of 2 parts cost to 1 part profit. It should be noted that base periods foster balance even while borrowing continues, but, the economy does not require the importation of debt or the exportation of unemployment via exports to prosper.
T-chart 20 consolidates net income (profit) on the left side of the table. This portion of National Income is the profits of private enterprise. If an equitable value is paid for tangible production and essential services owned or controlled by those individuals or companies engaged within the left side of the T-chart, these efforts will generate a residual profit above labor and interest cost. This creates sufficient barter power to deliver structural balance to the cost segments of the economy during the next cycle of production.
A specific level of National Income must be apportioned to the profit side of the economy to adequately support the wages, salaries, supplements, and net interest segments of National Income on the cost side of the economy. This can only occur if the price of raw materials at the beginning of the production cycle is economically balanced with the price of goods at retail.
In order to restore structural balance between the profit and cost producing sides of the economy, the Net Interest percentage of National Income must be reduced to pre-1970 levels. When this gain is applied to the non-financial profits of private enterprise, the private enterprise system will gain a like amount of profitability.
Interest costs must be reduced by at least 6 percentage points of National Income. This will translate to 6 percentage points of movement from the right side of the T-chart to the left side of the T-chart.
Reducing Net Interest is only one of several necessary steps toward National Income restoration, for without value correction measures, the economy continues to demand capital debt and unemployment, even with low interest rates.
Presently, interest and debt are replacing the "profits of private enterprise" due to decades of structural imbalances between the 5 segments of National Income. As profits deteriorate, less net income and more interest is earned and therefore, costs appear to be higher. If profits were higher, more National Income would be produced. This would reduce costs as a percentage of National Income even though total costs would not decrease in dollar value.
Today, interest costs are compounding within numerous sub-components of National Income. This drives up the cost segments of National Income, while underpriced goods and services reduce the profitability within National Income.
The increased use of interest tracks inversely with the general erosion of profits. This suggests that debt has been over-used as a means of creating money. Graph 4.1 reflects too much "debt monetization." Conversely, earning money into circulation that's backed by tangible value, produces a system called "raw materials monetization." This system increases profits and lowers overall debt and interest.
Today, America borrows to create money. This creates a growing tax against the profits of private enterprise.
DEBT EXPANSION IS A SYSTEMIC SYNDROME
Continuous borrowing causes the percentage of National Income earned as net interest (the interest costs associated with the profits of private enterprise) to over expand. Basically, too much debt is used in too many transactions. Borrowing to consume is substituting for spending profits.
America could sustain the current level of debt long into the future if interest rates remained very low (1% to 3%), but, low interest rates only solve part of the problem. The syndrome of deteriorating profits is a response to a National Income that has been allowed to deteriorate.
If the long term trend of deteriorating National Income continues, the percentage of National Income awarded to the profits of private enterprise will be exceeded by net interest around the year 2000. At that point, debt monetization will be the single most profitable enterprise in America. Then, rewards for unearned income will exceed the rewards for producing tangibles, and the profits of private enterprise will largely become the interest profit on capital debt expansion.
The total volume of Net Interest increased by 900% during the past 40 years from about 1% of National Income during the 1947-49 base period to the current level of about 9%.
Net Interest and labor supplements have dramatically increased as a percentage of National Income. However, wages and salaries without supplements have remained at the same percentage of National Income for 50 years (in the low 60% range). Supplements to wages have increased as a percentage of National Income and driven down the profits of private enterprise, but the actual take home pay of labor, as a percentage of National Income has remained constant. Labor takes home approximately the same percentage of National Income regardless of growth and demand. It follows that the most efficient method of raising the take home pay of labor is to increase the amount of National Income awarded to the profits of private enterprise. This will create more wages and salaries, and reduce unemployment.
Labor supplements (or the employer's contributions to labor) include health care benefits, social security contributions, and interest on the principal earned and borrowed from pension and retirement plans. Today, these supplements have reached an all time high as a percent of National Income. Interest costs and wage supplements are both liabilities to the private enterprise system. Therefore, at least two problems are systemic to the lost profitability of private enterprise:
(1) The increased cost of interest associated with the over monetization of debt, and;
(2) increased wage supplements and health care costs to business that never manifest as new profits in the economy.
The high percentage of National Income allocated to wage supplements and interest costs correlate to the problem of underpricing, and underpricing leads to further structural imbalances within the economy.
THE CONSISTENT RATIO OF GROSS SAVINGS TO NATIONAL INCOME
Raw Materials Economics finds that underpricing the production of the nation, the foundation of profits, is at the core of America's economic problem.
The discipline of Raw Materials Economics demands the study of National Income ratios. These ratios offer predictability to the American economy. One of these ratios compare two important statistical series: National Income, and Gross Savings.
The data on Gross Savings and National Income was found in the National Income and Product Accounts (NIPA book) provided by the Bureau of Economic Analysis (the BEA).
In their NIPA publication, "Gross Savings" is not specifically noted as a one of the five main segments of National Income, however, it is compiled from several components into an important sub-category. The Gross Savings sub-category is defined as: Gross Private Savings, or the sum of Personal Savings and Gross Business Savings, after adding or subtracting Government Surpluses or Deficits.
The most predictable ratio in the American economy is the ratio of Gross Savings to National Income. An approximate ratio of 1 part Gross Savings to 5 parts National Income has existed in the American economy since 1946.
Table 23 examines this ratio in annual averages, and then summarizes the ratio as 10 and 15 year averages. The consistency of this ratio at approximately 1 to 5 is most intriguing.
Table 23 begs the following questions. How can this consistent income to savings ratio exist? Didn't it change when Democrats or Republicans were in power? Doesn't it matter that America endured repeated recessions and debt driven prosperity? What about the cold war and defense buildups? What about the Vietnam war, the budget deficit, tax rate reductions, and higher taxes? Where are the results of increased efficiency? What about changes in supply and demand, interest rates, imports, exports, debt expansion? What about credit tightening by the Federal Reserve, the Savings & Loan failures of the 1980's, and other disasters such as hurricanes, floods, earthquakes, and bad trade agreements? How could a private enterprise economy maintain such a consistent income to savings ratio during five decades comprised of monetary and fiscal convulsions?
The answer is simple. Ratios reflect the physical economy. These ratios offer evidence that the study of economics is not the history of passing theories, but in fact a sister study to physics.
Other ratios are also governed by physical laws. These ratios track real profits in the form of metabolic and kinetic energy. These same ratios demonstrate that when profits don't originate from nature, they will eventually manifest as excess cost to the overall economy by finding their way to the right (cost) side of the T-chart. This will negatively alter future ratios.
A WEALTH OF CONFUSION
Table 23 uses ratios to illustrate that economics does not stand on a moving foundation of the so called "law of supply and demand," or a 1980's version of supply side theories which gave tax breaks to upper income Americans to increase spending and investing.
Table 23 is concrete evidence that economics has a structure that obeys physical laws. It is evidence that a national economy responds to deficit spending and interest rate manipulation the same way a welfare recipient responds to more welfare. The recipient spends the money, cuts back on future expenses, and immediately needs more money. However, welfare payments don't cure problems. In most cases the recipient becomes more dependent.
Table 23 illustrates that economics is not based on the failed principles of Karl Marx and Friedrich Engels, or the celebrated English economist, John Maynard Keynes (pronounced "canes"), who sanctioned President Franklin Roosevelt's efforts to borrow and spend America out of the "Great Depression".
If great thinkers like Adam Smith (the 18th century author of Wealth Of Nations) or John Maynard Keynes (the 20th century messiah of deficit spending) could have traveled into the future and retrieved Table 23, they would probably claim it for their own view of the world. Sadly, these men didn't have hard statistics that prove economic profits are simply net energy accumulation which manifest as fixed ratios of cost to income and savings. This is nothing new. It is simply the economic reflection of the 3 primary laws of thermodynamics which can't be altered.
Nicholas Georgeseu Roegen in his book entitled Entropy Law and the Economic Process (Harvard Press) said:
"Thermodynamics is the study and understanding of the physics of economic value."
Therefore, economics can be defined as the basic relationship between thermodynamics and tangible value. This truth is seated at the center of Raw Materials Economics.
GUARDING FICTIONS OF THE PAST
"A new scientific truth does not triumph by convincing its opponents and making them see the light, but rather because its opponents eventually die, and a new generation grows up that is familiar with the idea from the beginning" by: Max Planck, Nobel Prize winning physicist.
In the 16th century, Copernicus concluded that the sun is a stationary star and the earth revolves around the sun. This conclusion refuted the conventional wisdom of the preceding 1400 years. As a result of his findings, the Church became outraged and caused the books of Copernicus to be banned for the next 200 years.
A century after the death of Copernicus, the mathematician Bruno was burned at the stake for agreeing with the Copernican theory. Even Galileo was imprisoned for writing and speaking favorably of the Copernican truths.
Every period in history produces intellectual mavericks who are ignored, condemned, and suppressed by those employed to guard past fictions. To successfully bring forth any fresh truth, the proponents must penetrate many strong walls of ignorance by repeatedly performing tests that produce predictable and certain results. By so doing, the new truth is supported by measurable scientific facts.
The ratios of cost to income and savings in the national economy, as calculated within the discipline of Raw Materials Economics, can withstand such tests even when conducted by the most tenacious opponents of the new truth.
In forthcoming chapters, the permanent truths of Raw Materials Economics will be tested to conclude that economics is a quantifiable science, and a first cousin to physics.