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Monday, 14 November 2011

The three fundamentally different parts of the economy

The three fundamentally different parts of the economy

The economy consists of economic entities and economic items. Economic items have economic value. Accounting does not simply record what happened in the past. Financial reporting is not simply a scorekeeping exercise. Economic items are valued every time they are accounted. Accounting is a measurement instrument – per David Mosso. Utility, scarcity and exchangeability are the three basic attributes of an economic item which, in combination, give it economic value.

It is generally accepted that there are only two basic, fundamentally different, economic items in the economy; namely, monetary and non–monetary items and that the economy is divided in the monetary and non–monetary or real economy. However, non–monetary items are not all fundamentally the same.

The three fundamentally different, basic economic items in the economy are:
a)           Monetary items

b)           Variable real value non–monetary items

c)            Constant real value non–monetary items
The economy consequently consists of three parts:
1.            Monetary economy

2.            Variable item economy

3.            Constant item economy
1.   Monetary economy

          The monetary economy within a national economy or monetary union like the European Monetary Union (EMU) consists of the broad money supply (M3) of which about 7% is made up of actual bank notes and bank coins - based on the US money supply figures. The monetary economy is made up of money and other monetary items, e.g. bank notes, bank coins, bank loans, bank savings, credit card loans, car loans, home loans, student loans, consumer loans, commercial and government bonds, Treasury Bills, all capital market items, all monetary investments, etc. The monetary economy is the fiat money supply created in the banking system by means of fractional reserve banking.

             Bank notes and coins (cash) generally make up only about 7% of the money supply.  The other 93% of the money supply is made up of bank money (loan / overdraft / monetary application values in bank accounts) and other monetary items. They are non–cash monetary items. They have exactly the same attributes as physical bank notes and coins except that they are not present as cash. Their real values are being eroded by inflation and hyperinflation and increased by deflation in exactly the same way as with bank notes and coins.
            2. Variable item economy

The variable item economy is made up of non–monetary items with variable real values over time; for example, cars, groceries, houses, factories, books, property, plant, equipment, inventory, mobile phones, quoted and unquoted shares, computers, foreign exchange, TV´s, finished goods, raw material, etc.

           3. Constant item economy

The constant item economy consists of non–monetary items with constant real values over time, e.g. salaries, wages, rentals, all other income statement items, balance sheet constant items, e.g. issued share capital, share premiums, share discounts, capital reserves, revaluation reserves, retained earnings, all other items in shareholders´ equity, provisions, trade debtors, trade creditors, taxes payable, taxes receivable, all other non–monetary payables, all other non–monetary receivables, etc.

 
The variable item economy and the constant item economy make up the non–monetary. The monetary economy and the non–monetary economy constitute the economy.

Nicolaas Smith Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.