Monday, May 21, 2018

XYAB Economics: A GOLD Libertarian Analysis of Money, Trade, and Freedom

The Economics Book Your Economics Professor Doesn't Want You to Read

This book presents the XYAB theory of economics. The XYAB theory of economics takes the basic idea that people create value, people consume value, and people trade what they create in return for what they consume, and then explains how this simple principle can be applied to macroeconomics. It explores the role of money as a means for complex multi-point trades among economic actors, and why value must be created by someone in order for a benefit to be consumed, even if it is not created by the person who consumes its reciprocal. XYAB explains why "making money" means creating value, and why to spend money is to consume resources that someone else made.

XYAB is explained lucidly using the visualizations of the triangle of trade and the circular pool of value, with a combination of scholarly precision and real world wisdom that is readable and clear. Here you will see, in detail, why capitalism works, and why socialism is not a superior alternative.

Many arguments are made that you will not find in any other book, such as precisely why the government printing new money causes inflation, and how the creation of new wealth causes deflation that helps poor people in proportion to how few dollars they own. The XYAB theory illuminates complex issues of economics in a way that makes it easier to understand the libertarian defense of capitalism.

Necessary reading for any serious student of free market economics.

Chapter One: Making Money vs. Theft, Fraud, and Force

“He didn’t want to make money, only to get it.” –Ayn Rand, “Atlas Shrugged,” Part One, Chapter X, page 273 (Signet Paperback Edition).
In my opus of libertarian politics and economics, the nonfiction treatise “Golden Rule Libertarianism” by me (Russell Hasan), I present a bold new theory of economics, which I call GOLD. In the book, I explain the GOLD economics theories of how trade and the money price system are used to coordinate production and consumption in a division of labor economy, and why supply and demand interact with the price system to fine-tune economic efficiency in a capitalist economy. However, after I published the book, I realized that, while I had explained how things work in a good economy, I had not presented extensive detail on what goes wrong in a bad economy. This article will fill that gap.
To begin, I will summarize the GOLD theories of the triangle of trade and the pool of value, which is the core of the GOLD theory. Then I will discuss the difference between making money, which comes from producing a value and trading that value to someone else in return for a value to consume, vs. getting money, which happens when money enters your control without you having produced or traded values, and which is accomplished by theft, fraud, and force. I will proceed by analyzing, one by one, first theft, then fraud, then force. At the conclusion, as an added bonus for you, I will explain what the GOLD analysis tells us about how to make money and get rich.
1. The Triangle of Trade and the Pool of Value.
First I will summarize the theory in a way that can be visualized, and then narratively explain it. XYAB assumes two people, X and A, and assumes that X makes Y, and A makes B. Y and B could be anything, any value, that humans produce and consume in an economy: it could be a pizza that a baker bakes, or a painting that an artist draws, or an hour of labor sewing in a factory to make a dress. It could be anything represented by the abstract variable. There are then two eras, the ancient era, and the modern division of labor era. In the ancient era, X trades Y to A in return for B.
You can:
draw X and A,
write Y with an arrow pointing from X to A,
write B with an arrow pointing from A to X.
Those two simple arrows describe the first era, the simple barter economy of ancient times.
In the modern era, however, trade is a triangle, not a straight line. Here we introduce person C, who makes D. C represents all the third parties in the economy outside of just X and A.
Now draw a triangle.
Label the corners X, A, and C.
Along the outside of the sides of the triangle, label the sides:
Label the XC side as Y.
Label the AC side as D.
Label the AX side as B.
Now, in the middle of the triangle, write “$5”.
Look at the triangle. Can you see where I am going with this? To complete the picture, along the sides, draw pointed arrows parallel to the sides, in this way:
Y points from X to C, $5 points from C to X.
D points from C to A, $5 points from A to C.
B points from A to X, $5 points from X to A.
Look at it now. You can see it more clearly by this point:
X makes Y and consumes B,
C makes D and consumes Y,
A makes B and consumes D.
It should look like this:

In this way, money, as the representation of value in the economy, is the means for multi-point complex trades of various goods and services among diverse individuals. This is what enables the division of labor economy, where a person specializes in being good at making one narrow type of good or service, in his job or trade or career, then trades that one thing he makes to the rest of the economy, in return for all the various goods and services he wants to consume.
The only things that exist in the economy are the values Y, B, and D, which are traded for each other, with the money as a representation at each trade of the value present at the opposite corner. In a sense, (and I explain this at length in “Golden Rule Libertarianism,”) the money is merely a medium of representation, with no intrinsic value: the money’s intrinsic worth is merely the paper and ink it is printed on. As such, in the minds of most conventional economists, the money is an illusion that blinds them to what is really happening. But if the money itself is intrinsically worthless, then why does A give B to X in return for a $5 dollar bill?
X’s $5 is a sign to A of C’s D. When X hands $5 to A, A knows that there is value in the economy that can be bought with the $5, and he knows that, in this economy, a $5 dollar bill is a common medium of exchange, a representation of value. The $5 dollar bill represents $5 worth of value, actual objective intrinsic value, in the economy. This is why A hands B over to X: not because he wants the five dollar bill, merely a piece of paper with ink on it, but because he wants D.
X pays for the $5 he spends to buy B by making Y, because Y pays C to give D to A to compensate A for giving B to X. Thus, when the trade happens on each side, the triangle of trade is complete. Of course, in a modern economy with millions of members, the triangle evolves into what looks more like a circle with millions of segments, or, perhaps, it could even be visualized as a sphere with millions of lines between its different points.
To conclude this summary, when X makes Y, he “makes” the $5 that he hands to A, because Y pays C to hand over D to A for A to consume D, which is what A gets in return for handing B over to X. In this way, my theory explains what it means to “make money.”
Now for a far more detailed and less visual narrative. Let us first assume two people, Mr. X and Mr. A. X creates Y, and A creates B. The details don’t matter and this is intended to be a broad theory which accordingly would be true if one plugs any set of details into the variables. X’s job is to make Y, and A’s job is to make B. In a primitive economy 5000 years ago, X and A would live in the same little village, and if X wants to consume B and A wants to consume Y, then they would trade in kind. For example, if X is a blacksmith who makes horseshoes, and A is a farmer who raises cattle, they might trade one cow for a set of horseshoes.
Now jump ahead 5000 years. A modern economy is a division of labor economy, where every person is tightly focused on one particular trade, i.e. his or her career. Assume that X and A live again, and, once again, X makes Y, and A makes B. In a modern economy, Y and B are any value that can be consumed, including a consumable good or service or something that can be used as a tool to make such, and they may or may not be entire products, e.g. they could be tiny parts of a product built by a company, such as a pencil eraser or a car tailpipe. For this example, let us say that X is an auto mechanic in Los Angeles who fixes cars, so Y is auto parts, and A is a baker in New York who bakes cupcakes, so B is baked goods. Let us assume that X wants to order a batch of A’s cupcakes over the internet in order to eat them and give some of them to his children. X wants B, and would trade Y for B. However, A does not want Y. Mr. A’s care works fine and does not need new parts. The money system is what solves this problem, because money is a common medium of exchange that represents all tradable consumable value. X repairs a car and is paid $40, and X then pays $40 over the internet to A in return for A shipping a batch of chocolate cupcakes to X. A is willing to trade cupcakes for money instead of for a car repair because X’s money can be spent by A to buy literally anything else for sale in the economy.
Why is A willing to accept X’s money? Here is where the triangle in the “triangle of trade” comes into play. Normally economists look only at the transaction whereby X buys B from A for $40. What they miss, and what nobody pays attention to, is that the trade is a circuit, and the circuit is completed by a tertiary trade, such that the true cycle of trade is a triangle, which includes X, A, and a previously invisible third party, whom I call Dr. C. Generally, X buys B from A for money, A buys D from C for money, and C buys Y from X for money. The money flows in one direction along the triangle and in kind goods and services flow in the other direction. This must be true, because the money has no intrinsic value, but the goods and services are what gets consumed, so ultimately goods and services are what must be traded. In this example, there is a doctor in San Francisco named Dr. C. The engine in his car dies and he buys some car parts for a new motor from X for $40. C also has invented a new medicine for facial acne, called D, and A in New York has purchased a bottle of medicine D from C (i.e. from C’s business than sells his medicine) for $40.
The only things that really happened are that X produced Y and consumed B, A produced B and consumed D, and C produced D and consumed Y. In other words, the real economy is a series of in kind trades of goods and services for goods and services, not trades of money, although the money facilitates the trades. The money hides the fact that the only real things in an economy are production, trade, and consumption, and the money merely makes trades possible as a common medium of exchange to represent good and services, without adding anything fundamental to the picture. In a division of labor economy with millions of economic actors, like the USA, the triangle of trade is more like a big circle of trade, with hundreds or thousands of people all trading value in one direction with money flowing back in the other direction.
I say that X’s Y “justifies” or “backs” the $40 that X pays to A because the real reason that A gives B to X is not X’s $40 that X pays to A. Instead, the real reason that A sells B to X is the D that C gives to A when A pays X’s $40 to C. And C gives D to A because X gave Y to C. So, when X makes Y, when X produces Y or does whatever work his job entails that creates Y, when Mr. X creates the consumable tradable value that is Y, X is literally “making” the $40 that he pays to A for B, because he is justifying and backing that money with the value that he produced. This is how the triangle of trade explains the phrase “making money.”
When an economy includes, not hundreds of people, nor thousands of people, but literally hundreds of millions of people and billions of trades, then it stops looking like a neat simple triangle or a circle, because there are more than three trades or 100 trades, and instead it looks like a big blob with a billion interconnected trades, which I call a “pool.” GOLD economics can be characterized using the pool of value theory, which analyzes this blob using the an extension of the triangle of trade theory. This theory states that when a person works a job, he creates value and puts it into the economy’s pool of value and gets money back, and when he buys something he takes value out of the pool and puts money back in. Although I won’t provide an illustration, one can envision a circle, with X above the circle, and two lines that connect X to the circle. Along one line, X puts value into the circle and takes money out. For example, getting a salary of $10 for an hour of employment. Along the other line, X puts money into the circle and takes value out. For example, buying a sandwich and coffee for $10. One could just as easily add A and C along the left and right, each with those same two types of lines, one line of putting in value and taking out money, the other line of putting in money and taking out value. To flesh it out further, write an entire alphabet of letters connected to the circle that same way. That circle is the pool of value. The circle gets so big that there comes a point where people, and economists, forget that it is merely an enlarged triangle. But, in fact, X pays for the value that he consumes by means of the value that he produces and puts into the circle.
Under this theory, the total money supply must equal the total pool of value in the economy, because money represents value, so all the money must represent all the value. The pool contains all the goods and services in the economy, and people get money by adding to it, and then spend their money to subtract from it. Thus, to make the money that you get, you must place into the pool of value an amount of value to “back” the money you are taking out, i.e. to make your money.
The pool of value theory explains why printing money causes inflation, because, for example, if there are only 200 dollars in the money supply and only 200 apples in the economy, and the money represents the pool of value, then the value of one apple will be 200/200, i.e. one apple will cost $1. But if 200 new dollars are printed and now 400 dollars corresponds to 200 apples, the value of one apple will be 400/200, so inflation will drive the price of apples from $1 up to $2. Observe that in this scenario, the government has stolen 100 apples, because it can use the newly printed $200 to buy 100 apples out of the economy without having created any value to “back” that newly minted 100 dollars, so the dollar-owning private economy loses 100 apples and those 100 apples are “redistributed”. Observe also the logical conclusion of this reasoning that inflation does not help the economy, contrary to Keynesian dogma, because printing money creates more money for people to “get” money, but it does not “make” any money because it adds nothing to the pool of value. By further extension, good economic policy focuses on growing the pool of value, not on growing the money supply, and free trade is the policy that accomplishes this real growth.
I also call the pool of value theory the “correspondence theory of money,” because it posits that money corresponds to the pool of value, in much the same way that words correspond to the objects in reality according to the correspondence theory of language. The word “apple” represents any real apple, and a dollar represents any real value that you can buy with it.
Most people do not make something and sell it themselves. Instead, they work as employees and do work for an employer. But, even in this situation, each employee creates a value, which the employer collects, aggregates, and sells to other buyers. The employee sells the value he creates, i.e. his work, to the employer, and the employer trades money, i.e. salary, to the employee in return for that value. The big picture is that the employees all add value to the finished product, and the employer then sells the finished product for money and takes the money and pays each employee a salary for what he contributed to the finished product. So, in reality, each person is trading produced value for money which he will then spend to buy value to consume. Even in the employee-employer model, each employee “justifies” his salary by the work that he does. To frame this using the pool of value theory, when you do work for your employer, you put the value that you create into the pool and get back your money salary, and when you buy things you give your money back and pull value out of the pool.
Subpart 2. Making money vs. getting money.
In her novel “Atlas Shrugged,” in Part One Chapter X, there is a sequence of scenes wherein the heroes discover an abandoned factory. For a complicated reason, they seek to learn as much about the factory as possible. They learn that once, the factory was productive and made motors that were sold, but the factory collapsed under owners who did not care about profit. The factory went bankrupt and was sold to a series of crooks who stripped it of its equipment, furniture, etc. The factory was sold to two different people, so its legal status collapsed, and nobody could claim that they owned it, at which point looters broke in and stole everything that was left. During this investigation, over and over again, the heroes talk to idiots who seem to believe that the only way to get money from the factory was to take the objects out of it, like the equipment and furniture, and sell them, or to sell the factory to a sucker. The idea of actually running the factory and making motors to sell, and making money from the factory by creating value and trading it in the economy, does not occur to any of them, although, by implication, it does occur to the heroes.
Rand uses this sequence to point out the difference between making money and getting money. My GOLD theory completes the analysis begun by Rand, by explaining exactly wherein lies the difference. If you seek to make money, then you seek to create a value to trade with others in order to add meaning to the money that you handle. For example, in the triangle of trade example, when X gives $40 to A for B, the value to back up that $40 is the Y that X created and traded to C. Under the pool of value theory, you make money by creating value and placing it into the pool of value to justify the money that you take out. In contrast, getting money without making money consists of pulling value out of the economy without adding any value into the pool of value. In the triangle of trade, getting money breaks the circuit by getting a consumable good or service from someone without having to create value and add it into the triangle through trade with others.
This is almost always accomplished by getting physical money without creating the value to back the money and add meaning to the money. No one is going to feel forced to just give value to someone in return for nothing, but if a thief gets his hands on money, then he can use that money to get value by trading it to other people who see only the money and don’t see whether it was made or stolen. The person who created the value consumed by the thief, i.e. the person who takes the thief’s money and gives value to the thief, will not know that the money was stolen, and will not be able to see through the complicated web of trades to know that the thief never created any value to deserve to consume what the producer created. The victim of theft, who was robbed, will have been entitled to consume the value that the thief consumes, but this person could be miles away from wherever the thief goes to spend the stolen money.
Unfortunately, in a sense, getting money, as such, includes both making money (where you get the cash you made) and getting money illicitly, by fraud or theft or force. In both scenarios there is a sum of money that a person gets or gets control of. However, to keep our definitions clear and concise, I distinguish “making money”, as getting money legitimately by making the value that backs it, from “getting money,” by which I mean getting money illegitimately, getting money without making any value that is traded for money to back the money that is obtained.
Subpart 3. Theft, fraud, and force.
Now, having laid our theoretical framework, we can see how theft, fraud, and force work. Theft, fraud and force all consist of getting money and then spending that money without having created anything.
In theft, a thief uses force, e.g. a bank robber with a gun, or deception, e.g. picking someone’s pocket, to take money from a person who rightfully owned that money. The thief then spends the money to consume the value that rightfully should have gone to the money’s true owner. One of the core teachings of GOLD economics is that the total amount of value that is consumed cannot exceed the total amount of value that is produced, so when someone consumes a value without producing anything, there is necessarily one or more other people who are forced to produce value without consuming the corresponding value they could have traded for. It is in this sense that theft makes the producers into the slaves of the thieves.
Consider again my example of X, A, and C. Now suppose that, after X repairs C’s car and gets $40 of payment from C, and thief named Z breaks into X’s home and steals $40. Z then buys $40 worth of baked goods from A, and eats them. The production is still the same. Y, B and D get produced. But the consumption is different, because X must now go hungry despite deserving cupcakes, and Z gets to eat when he did not do any productive work. If we could see the network of trades of in kind goods for in kind goods, then A would ship his baked goods to X instead of Z, because he would see the trade of Y to C, which justifies A’s sending the cupcakes due to the D that C traded to A. But, because the system of trades is so complex, we only see the money that gets traded. A sees Z’s money and A must assume that it is legitimate because he can’t see where Z’s money came from, so A sends the baked goods to Z, when they should have gone to C. In essence, Z forces X to be Z’s slave and work for Z by creating the value for C that makes A give value to Z.
Under the pool of value theory, a thief puts money into the pool and takes out value, but he never put value into the pool to get that money, instead getting the money through evil acts. If replicated on a large scale, this would result in massive consumptions of value with no corresponding productivity or creation of value. Under this scenario, either producers will become slaves, and produce value for the thieves without getting anything in return, or else the producers will stop producing, and the pool of value will shrink.
Now let us consider fraud. Fraud could mean that a person who makes a trade is deceived about what he received on his end of the trade, but I define it more broadly to mean that a person did not get what he wanted. The analysis is similar to the analysis of theft. A sends B to X in return for X’s $40, but in reality, it is really in return for C’s D that A buys for $40. Now assume that the medicine D does not work, or is not what A wanted, or C lied to A about what D does. Perhaps D makes A’s hair turn blue, and does nothing to cure his acne. A created a value worth $40, but A has not gotten to consume the value corresponding to what he produced and traded away. This, again, makes A into a slave, producing value for others to consume while getting nothing in return. C, who defrauded A, gets his $40, and uses it to buy car parts from X. The villain gets money without creating value to justify that money, but in this case, he gets money by fraud instead of by violence as with a thief. According to my theory, if A created $40 worth of value and A does not receive exactly what he chose to buy for $40 in return then A was defrauded by C. In normal situations, this will be identical to A failing to receive the $40 worth of happiness that he paid for (normal meaning that a person chooses to buy the things that will make them happy). This is why, in “Golden Rule Libertarianism,” I include a section in the discussion of contract law which focuses on returns policies, because a person should generally be able to void a trade if they did not get what they wanted or did not get what they thought they were getting.
Here let’s consider force. As distinct from theft or fraud, which can be done by private individuals, I define force as the systematic distortion of trades in an economy executed by a government using the power of the guns of the police and army to enforce its economic distortions, i.e. the government acts by force. There are two types of force: taxation and regulation. In taxation, the government takes money from private individuals who have earned it, and gives to other people or, as more frequently happens in reality, wastes it on government spending programs that destroy the money without giving anyone what they actually want. As I explain in my book, in a free market economy a trade only happens if two people freely choose it, so the free market economy is what people have chosen. By definition, the economy created by force is different from the free market economy, therefore it follows as a logical necessity that the economy created by force is not what people would have freely chosen, and therefore it is not what people want. By definition, the difference between the economy of force and the free market economy is what the people would not have chosen but which the government chooses for them. This touches upon the basic GOLD theory, which is that, according to the Golden Rule (“treat other people the way you want them to treat you”) you should give freedom of choice to everyone else so that everyone else will let you be free to make your own choices. When GOLD is violated, the result is force, because force was used to override the result that would have resulted from freedom.
We can see that taxation is basically the same as theft, in practice. The government takes money from the productive and then spends it. When X creates $40 worth of Y and trades it and (to simplify the example) on that trade $40 is taxes away as income tax and sales tax, then this makes X into a slave, and steals the value that X created. Using the pool of value theory, X puts value into the pool but gets nothing out of it, while the government takes value out of the pool and places nothing into it. In fact, the government is actually taking Y from X and giving nothing to X in return. This fact is obscured by the role that money plays in what happens. The voters see the government taking tax money from X, and this looks less evil and scary than what is really happening, which is that X is a slave of the government, and X works for the government, to the extent that X makes the value that backs the money taken from him as taxes. True communism, where the people work openly for the government as economic slaves, scares mainstream American voters, but the liberal tax and spend politicians use money to hide what is really happening in a tax-based system, which is a degree of communism to the extent that the worker’s created value is taken by the government by means of taking as taxes the money backed by that worker’s created value.
We can also see that regulation is fundamentally akin to fraud because people don’t get what they want and what they paid for. In a free market economy, the trade of Y for B, or of Y for B for D, would naturally happen. A regulation by definition blocks a trade that would have freely happened or directs that one value be traded for something else other than what the traders would have freely chosen. It must be true that regulation by definition distorts the trades that would have been freely chosen because if all freely chosen trades were to happen then the regulations would have no need to exist. Returning to our triangle of trade example, let us say that, in the interests of food safety, a regulator enacts a regulation that bakers in the eastern USA may not ship boxes of cupcakes to buyers in the western USA, lest they go stale while being shipped over a long distance. We have already seen that, in a free market economy, X would buy cupcakes from A. This is the free trade that would complete the circuit of triangle trade, if it were allowed to happen. A has baked the cupcakes, and X would choose to buy them.
But because of this regulation the trade is forbidden to happen. Now, instead, X must keep his $40, and the cupcakes sit idly on the shelf in A’s bakery, unsold, until they go stale. In one sense, A’s cupcakes have been stolen from X and $40 has been stolen from A, but in another sense, B has been taken from A, to be disposed of as the regulators see fit. The trade is exploded and X and A do not trade value for value, similarly to a fraud, except that with fraud, a sham trade happens, and with regulation, no trade happens at all.
In a trade-based capitalist economy, trade is what connects producers to consumers in a circuit, and it is the prospect of trading to get what you want to consume which motivates the producers to produce. The more regulations and taxes, the fewer the trades that would otherwise have been freely chosen. Thus, regulation and taxation will directly correlate to a decrease in wealth in a free market economy. For example, if $40 of tax money is taken from X, then he is not allowed to take the value out of the pool that he put in, which will kill his motivation to work. Specific to the example of regulation, the trade of B to X for $40 was a key part of the triangle of trades between X, A, and C. Because of the regulation, A doesn’t have the $40 to buy medicine from C, so C won’t have the $40 to buy car parts from X. The regulation breaks the circuit in the circle of trade and wreaks havoc on the delicate money mechanism that coordinates purchases and sales in a capitalist economy.
Three important differences exist between government force on the one hand and theft and fraud by private criminals on the other hand. First, a person can legally protect himself from criminals, but there is no legal protection from taxation and regulation. Second, when a private thief steals money, he spends it on what he wants to make himself happy. In contrast, when the government spends taxpayer money to help the poor, or for whatever other bizarre reasons are politically in vogue, the money buys things that were not freely chosen by the poor people or other interested parties for whose benefit the money want spent, nor were the purchases chosen by the taxpayers. Instead, the money funds projects chosen by the broken, failing system of bureaucracy and crony politics. So, more often than not, nobody gets anything they wanted while billions of dollars are wasted and everyone ends up poorer.
Third, in a normal capitalist society, theft and fraud will be the exception. On the other hand, in a liberal/socialist society, force will be the norm and free productive trade will be exception. Because force, like theft and fraud, essentially transforms the productive into the slaves of the looters, either productive people will produce as slaves with nothing in return and the value that is produced will be consumed by people who trade nothing to the producers who made it, or, as will more likely happen, the productive people will lose their motive to produce, they will stop producing, and the pool of value will get smaller. Then, with a smaller pool of value, everyone will be poorer, which will prompt the government to stage further inventions (such as printing more money, which will lack any new value to back it), making things worse (e.g. massive inflation), and the economy will collapse into a downward spiral. This is precisely the nightmare scenario fully explored in Rand’s economic novel “Atlas Shrugged,” and, especially in dark times like the Great Recession, we have the possibility that our fact will mirror her fiction.
Also note that, as the dark times come, people will lose the understanding of the meaning of money, that money represents value and money is made by creating value to trade, because the government will have severed the connection between money and value. Lacking such understanding, more and more people will seek only getting money instead of making money, and the entire populace will fall into a mindset of force, theft, and fraud.

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