Profits   Its Connection with Rising and Falling Prices
Made in Atlantis
Contents
We live in a Money and Profit Economy
The Circuit Flow of Money and The Annual Equation

The processes which bring about this deficiency in consumer purchasing power are intricately involved in the financial mechanism whereby goods are now produced for sale at a money profit; they are purely money and profit phenomena; they had no part, as we have seen, in the simple community in which our pioneer produced and bartered goods.
By an examination of corporation balance sheets, both real and hypothetical, involving various uses of profits, an attempt is made to show how the financing of increased production out of profits, and the savings of individuals and of corporations, bring about a flow of finished goods during a period of prosperity in excess of the flow of consumer income, and thus bring prosperity to an end.
To discover how this deficiency is brought about, one must first understand the characteristics of the circuit flow of money from consumers, through the hands of profit-making producers, back to consumers, and the conditions which must prevail if consumers are to obtain enough money to buy the output of industry at the rate at which it reaches the markets.
The Annual Production-Consumption Equation
Since the using up of goods by final consumers is the end of industry, production must slacken, and thus render increased consumption impossible, unless products find their way to consumers about as rapidly as they are produced. This condition prevails, obviously, as long as there is close and continuous correspondence between the dollar-sales of consumers' goods and the output of these goods measured in dollars at prevailing prices. In other words, business as a whole is sustained as long as people continue to use up commodities at the rate at which they are being prepared for use.
But this unqualified truism does not explain business depressions. It goes without saying that in the course of time men use up nearly all that they produce, and no more. If we take into account a sufficient number of years, it is true that 'goods cannot be sold for consumption more rapidly than they are produced.' But time is the essence of our problem. For a time goods certainly can be sold for consumption more rapidly or less rapidly than they are produced. To keep business free from extreme fluctuations, production and consumption must balance within a sufficiently short period of time.
But what is a sufficiently short period? For our present purposes, we need not be more precise than to say that variations in the state of business activity will be slight if the desired balance occurs within twelve months. Nature is responsible for an annual business cycle. Because of seasonal fluctuations, both in production and consumption, from which there is no escape, the cycle of the year is the shortest period of time within which we may reasonably hope to approach closely to a balance of output and demand. This balance we may call the annual production-consumption equation. For convenience, we may call it simply the annual equation.
Overproduction
It is with reference to this equation that the term 'overproduction' has its chief meaning. As there is no known limit to human desires, it is not possible to turn out goods in general over and above the wants of mankind. Nowadays, the term 'overproduction' is seldom used in this sense either by business men or by economists, for they are well aware that capacity for consuming with satisfaction has always kept far ahead of capacity for producing.
The traditional argument against the possibility of overproduction, though it does not err in using the term with reference to human desires, makes an error which is more serious because more subtle. How absurd it is -so runs the argument -- to imagine that the supply of goods can possibly be greater than the demand for goods! As a matter of fact, demand and supply are one and the same thing. Is it not clear that when I drive to town with a load of hay, the hay is my demand for goods and at the same time another man's supply? I have added to demand and to supply exactly one load of hay; the balance between supply and demand remains precisely what it was.
To be sure, I may sell the hay for money and then spend the money at the harness shop; but I must not allow the fundamental nature of the transaction to be obscured by a mere medium of exchange. I have only to imagine a state of barter to see clearly that nothing really matters in this transaction except its two commodity ends. I disposed of a load of hay; I acquired a new harness; what the intermediary happened to be is of no consequence. It is true that there may be a distressing lot of hay in the market, while harnesses may be comparatively scarce. In that case, there has been a relative overproduction of hay; but obviously not all goods can be relatively overproduced. Consequently, there can be no such thing as general overproduction. This argument is typical of the errors that men fall into when, disregarding the essential difference between barter and money markets, they focus their attention on goods and overlook the 'mere medium of exchange.'
That not all goods can be overproduced in relation to each other is an axiom. If, therefore, we follow the instructions of some writers and consider nothing but goods, the idea of general overproduction seems absurd. If, on the other hand, we consider all that may happen to the medium of exchange, we see at once that there may readily be a general overproduction of goods in relation to the money which consumers offer in exchange for goods. That is to say, the annual equation may be upset. As a matter of fact, every recession in business activity is marked by this kind of overproduction or by the fear that it is imminent. Of this there can be no doubt. But the fact that this deficiency of purchasing power is, as we believe, the chief cause of our failure to sustain prosperity, remains to be demonstrated.
The Circuit Flow of Money
In any event, production cannot long be increased without a proportionate increase in consumer expenditures. The volume of these expenditures depends mainly on the size of consumers' incomes, and the size of these incomes depends, in turn, mainly on the total volume of money in circulation. But this is not the only factor. The size of consumers' incomes is also determined in part by the frequency with which money, once spent in consumption, is returned to consumers; that is to say, the average time taken by money to make the circuit from expenditure by consumers, through various other uses, mainly in connection with the production of goods, back to another expenditure by consumers. This flow of money, therefore, from use in consumption to another use in consumption should not be overlooked in studies of the causes and conditions of business fluctuations and of the means of reaching higher standards of living. What we have come to call the business cycle is a composite of many cycles -- cycles of wage-rates, wholesale prices, farm rents, profits, volume of production, growth of capital facilities, and so on. Among these periodic movements are variations in the circuit flow of money.
There are streams of commodities and streams of money which in a literal sense are constantly, though not steadily, moving in opposite directions. For the most part, raw materials are grown, extracted, and graded; moved on to factories and prepared for final consumers; moved on to wholesalers; thence distributed to retailers; and finally turned over to consumers. At the same time, streams of money are moving in the opposite direction -- a main stream becoming smaller and smaller as it flows from consumers to retailers, from retailers to wholesalers, from wholesalers to manufacturers, from manufacturers to producers of raw materials, and thence, mainly in the form of wages, back once more to consumers. This circuit movement characterizes the flow of money, but not the flow of commodities; for when commodities get into the hands of consumers, they are usually disposed of, and thus withdrawn forever from the stream, whereas most of the money that reaches consumers is, on the contrary, invested or paid by them to retailers and to others, and thence proceeds around the circuit.
This stream of money from use by consumers in the purchase of new goods back to another use by consumers in the purchase of new goods, we call the 'circuit flow of money.' The rate of flow we call the 'circuit velocity of money.' By that term we do not mean what economists call the 'velocity of money,' namely, the frequency with which money is used for any purpose whatever. We are distinguishing between the velocity of money in general and the velocity of money that is used in the purchase of goods for consumption. This distinction -- though rarely, if ever, made -- is important. When, for example, bank deposits are turned over more rapidly in connection with increased sales on the stock markets, there may or may not be -- probably never is -- a corresponding change in the turnover of bank deposits used to pay for consumers' goods. Nor is money spent more frequently in retail markets merely because it is spent more frequently in wholesale markets; money may work faster in order to pass wool and woolen goods through more hands on their way to clothiers' shops, without passing more wool through warehouses and more garments through the shops. This is, in fact, what happens as prices rise and speculation in commodities becomes profitable; additional middlemen make use of money without making additional sales to consumers.
It follows that both velocity and quantity of money might remain constant -- that is to say, people might have the same amount of money and spend it as rapidly as ever -- and yet the markets might sense trouble. For if people decreased the amount spent for new goods within a given period of time, and to the same extent increased the amount used in other ways, they would thus decrease the circuit velocity of money; and they might thereby temporarily depress business, without decreasing the velocity of money. Under certain conditions, therefore, the turnover of money as a whole may have less to do with business fluctuations than the turnover of money in its particular function of moving goods into the hands of consumers.
The Flow of Money and the Flow of Commodities
Upon the rate of flow of money into the reservoir of personal incomes largely depends the even flow of commodities from producer to consumer and the consequent maintenance of the annual equation. Whatever interferes with this stream tends to retard the flow of commodities and thus to disturb business. Sometimes money gets sidetracked in hoards, in cash balances, even in banks, and is unemployed for an unusually long time. Sometimes consumers' incomes are increased out of proportion to increased production. At other times, not enough money flows into consumers' hands to maintain the production-consumption equation; finished commodities increase more rapidly than expenditures. In general, whatever causes the flow of money to consumers to lag behind the flow of finished commodities interferes with further production.
Business stability, then, as far as it depends on money, is concerned primarily with the rate of flow of money into consumers' hands. It does not necessarily make any difference how much money is in Government vaults, or is frozen in loans, or is idle in hoards, or is carried in pockets and tills or in bank balances, provided the volume of money thus withheld and the volume of commodities coming upon the markets remain the same from day to day. Only changes count.
Factors That Alter the Circuit Time of Money
Our next question is: What factors retard or accelerate the flow of money from consumer back to consumer? This question would not concern us if money actually flowed through the channels of commerce as steadily as in our diagram. Here we have pictured all the pipes as unobstructed, unvarying in size, free from leaks, and without sources of additional supply. If the circuit flow of money were such, day in and day out, that we could accurately represent it by means of such a simple and static picture, and if the flow of commodities were equally steady, industry would be perfectly stable. There would be no business cycles. But money never does flow through the arteries of trade as steadily as this, and variations in the rate of flow come more rapidly in some parts of the circuit than in others. These facts might be suggested by means of gate-valves in all the pipes, subject to the control of governments, corporations, and individuals. Nothing but a motion picture, however, could show all these multifarious and kaleidoscopic changes. So it is only in a general way that our simple diagram can help us to visualize the major movements. Not until we consider in what specific respects this diagram fails to depict what actually happens to money during the circuit, are we prepared to consider the means of maintaining business stability and the annual equation.
Perfect Stability Unattainable
Perfect stability is unattainable since few of the various factors that cause instability are subject to complete social control. Ripples on the business seas there will always be, even if there are no billows. An exact production-consumption equation, a balanced condition of the industries, a circuit flow of money perfectly adjusted to the flow of finished goods -- this goal society can never reach. Maladjustments are inevitable, if for no other reason, because consumers have freedom of choice.

At best, individual producers cannot be fully informed concerning demand; and even if they knew all about consumers' present desires and buying power, and all about the schedules of other producers, and all about the weather in the coming season, and even if they planned accordingly, and even if they succeeded in carrying out their plans -- all of which is impossible -- still, production would be unbalanced, because both the desires of consumers and their effective demand would change before the goods could be placed on sale. At any one time, consequently, there is certain to be relatively too much of this in the markets and too little of that, as well as the far more serious condition of too large or too small a total volume of goods in relation to total consumer demand.



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Profits  Its Connection with Rising and Falling Prices
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