Friday, June 26, 2015

The economics of democratic communism: money, savings, interest, and inflation

There are two units of account: the SVU and the currency. One SVU denominates an hour of commonly skilled labor of ordinary intensity under ordinary conditions. It is the basic "minimum" wage, in the sense that any individual may demand up to 40 hours work, of ordinary intensity and under ordinary conditions, per week paid at one SVU per hour. Multiplying dollars per hour of work for uncommonly skilled labor, and/or labor performed with less or more than ordinary intensity and/or under less or more than ordinary conditions, the SVU becomes a measure of the socially necessary labor time. For example, if I have to pay 5,000 SVU for 4,000 hours of labor to produce 1,000 widgets, then the socially necessary labor time for one widget is 5 SVU.

It is not strictly illegal to not work, nor to work as few hours as one wishes, nor to accept a subminimum wage. However, except for very rare exceptions, every individual must pay his or her basic tax (e.g. 12 SVU per week or 600 SVU per year), and can be compelled to work to pay it.

Contracts (especially employment contracts) can be denominated in SVU, but the SVU is itself not a store of value: there is no liquid instrument that a person can hold that entitles her to 1 hour of ordinary labor or the products thereof.

There is also a currency, which I'll call a "dollar" (which is not a 2015 US dollar). Unlike the SVU, the dollar is a store of value: a person can hold liquid instruments (physical cash or checking/savings accounts) that entitle her to a dollar's worth of goods and services. The government sets the exchange rate between SVU and dollars; the government is constrained in setting this exchange rate to the extent that a person earning 12 SVU per week in disposable income must be able to pay his or her basic expenses: housing, food, clothing, utilities, and some basic luxuries. The dollar is subject to a built-in intentional inflation rate, probably between 2-4 percent per year, drt by the national government. The inflation rate is, essentially, a wealth tax.

There are two kinds of liquid bank instruments, denominated in dollars: checking accounts and savings accounts. Checking accounts accept deposits after taxes, and can be withdrawn without additional taxation. Money in checking accounts can be inherited, subject to inheritance taxes. Savings accounts accept deposits before taxes, but taxes must be paid when withdrawn. Furthermore, savings accounts cannot be transferred; to transfer the money in a savings account, the account holder must withdraw the money, pay her own taxes, and then transfer the after-tax income (which is probably subject to double taxation: the receiver must pay taxes on any amount transferred).

Neither account pays any nominal interest. The point of savings accounts is to smooth taxation for people who have large short-term increases in income. Since there's built-in dollar inflation, saved money loses value over time. For short-term smoothing, the losses from inflation should be minimal, and, because they're expected, can be built into short-term high-income labor contracts.

For example, a person who welds the Alaskan pipeline for a year, and and wishes in that year to make 5 years (including the initial year) of income at 40 hour per week. Assuming \$10 per SVU in the initial year and a 4 percent expected inflation rate, she would require \$108,340, or 10,834 SVU in the initial year; she spends \$20,000* on taxes (\$6,000) and living expenses (\$14,000) the first year, and deposits \$88,340 in a savings account. Over the course of five years, she would pay \$32,502 in taxes (assuming 12 SVU per week in current year dollars). Even with inflation, this is a considerable savings vs. paying the higher marginal taxes on 10,800 SVU all at once.

*Remember, these are not US dollars; \$20,000 should have the equivalent purchasing power to about 60,000 2015 US dollars

Savings accounts so structured make bad vehicles for people with permanently large incomes, because inflation is compounding. People with high incomes will probably use these accounts, but they will lose substantial value over time. This is by design: under democratic communism, people should depend on their labor, not their wealth, for their standard of living.

Since there are far fewer reasons for demand shocks, inflation should be very predictable: the government (central bank) should rarely need to raise inflation to offset debt overhang. (As noted earlier, debt beyond one's guaranteed ability to pay is hard to get and easy to default on.) However, the SVU makes inflation a little trickier to deal with.

We have to deal with two quantities: the price index in dollars and SVU and in dollars. The dollar price index is the dollar price of some basket of goods; the SVU price index is the dollar price divided by the current dollars/SVU exchange rate. As labor productivity increases, we should see the SVU price index decrease: things should require less socially necessary labor time to produce.

Assume in some arbitrary reference year the that the SVU price index is 10 and the dollar price index is 100, so we have a \$10 to 1 SVU exchange rate. We have a two percent increase in productivity, therefore a decrease in the SVU price index: it becomes 9.8. We want a 4 percent inflation rate, therefore we set the dollar price index to 104. This therefore means that to give workers the productivity gains, we should set the dollar to SVU exchange rate to 104/9.8 = \$10.62 per SVU (rounding up). This becomes the dollar minimum wage. Essentially, then, we have 6.2 percent more money chasing 2 percent more goods with a nominal (money) inflation rate of 4 percent. Note that this means the implied inflation losses in savings accounts is 6.2 percent per year. This also means that the standard nominal interest rate for loans in dollars is also 6.2 percent per year.

Although loans denominated in SVU will in some sense have a implied interest rate of 6.2 percent, wage inflation will reduce this rate. Suppose a person borrows 50 SVU (\$500) in year 0, and begins to repay the loan the next year. He will have to pay 1 SVU per week, which means he will pay \$10.62 per week or \$531 total. Assuming he's working 40 hours per week he's still repaying 1/28th of his disposable income. Because productivity has increased, he's foregoing the consumption of 2 percent more goods than he gained the previous year. So, in dollars, he's paying 6.2 percent interest; in SVU he's paying zero interest; in real goods and services he's paying 2 percent interest.

The government always loans to individuals in SVU at zero nominal interest. Firms and individuals can loan to individuals either in SVU at zero interest or in dollars at any interest. SVU loans are enforceable: individuals can be compelled to repay their loans when so doing will not cause their disposable income to drop below the minimum (12 SVU per week). Private loan repayment is always subordinate to government loan repayment. Loans made in dollars are not enforceable: an individual can arbitrarily default on a dollar loan without a monetary or criminal penalty. Hence, one should make dollar loans only if the borrower has a good reason to pay you back, e.g. to maintain his or her reputation.

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