Owner-Specific, Non-Economic Assets

No matter whether someone is completely innocent of economic understanding, or if they have a doctorate or even a Nobel Prize in economics, there is still a high probability of failure to believe that certain economic assets can lose their entire economic value depending on who owns them. This phenomenon arises in a wide variety of situations, some of which are noted below.

1. If I write a check to CASH against my checking account and accidently leave it in my pocket through a laundry cycle, has its destruction resulted in an economic loss to me? No, the check only attains economic value when it is acquired by someone else. If they subsequently destroy it, they have lost the money value for which it could have been cashed.

2. When the coffee growers' cartel in Brazil burns part of their crop, are they destroying an economic asset? No, they are protecting the value of the part of their crop that they actually do sell on the market. This is a general result. A monopoly supplier of a product, given no possibility of price discrimination or delayed sales, suffers no economic loss in destroying a surplus quantity of a product beyond that which can be supplied to satisfy market demand at a profit-maximizing price.

3. When a US Treasury warehouse suffers a fire that destroys stacks of newly printed $100 Federal Reserve Notes, has it suffered an economic loss? Only the same loss of labor and material production factors that would have resulted if the notes were $1 instead of $100.

4. If an audit of the Social Security Trust Fund finds that Franklin Raines had somehow managed to transfer the special non-marketable Treasury Securities to a Fannie Mae slush fund, the Clinton Library, and the Eliot Spitzer NY gubernatorial campaign fund, would the future ability of Social Security to pay its obligations be impacted in any way? No, assuming that a general revenue tax deficit still exists in the future, the redemption of the Trust Fund Securities will be accomplished by the issuance of new public Treasury debt, and the proceeds will be used for the future SS payouts that exceed the future payroll tax receipts. The special Treasury securities thus provide exactly no improved capability to pay future SS obligations as the same new debt will be issued. Moreover, even if actual money were locked up in the Trust Fund, the effective ability of the government to print new money at will makes the actual stored contents of the Trust Fund economically irrelevant.

5. When a public company re-purchases its stock from the market, or when it prints up but does not issue new shares, the shares that it holds are not ecomnomic assets as destroyed shares can be replaced without significant cost and the shares that the company holds have no effect at all on the distribution of company ownership.

While misunderstanding of this issue is widespread, the late science fiction master Robert Heinlein gets it right in Time Enough For Love, pages 290-292 of the hard cover edition. Colony planet New Beginnings banker Ernest Gibbons (Lazarus Long) :

"... But the important part is where it says that this bank will accept that note at face value in payment of debts to the bank." Gibbons took out of his sportan a thousand-dollar banknote, set fire to it... "Wastepaper, Duke, as long as it's in my possession. But if I let it get into circulation, it becomes my IOU that I must honor...."

Any additional examples of economic full value discrepancy between assets owned and assets released would be appreciated.

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Software seems like a good

Software seems like a good example, but there is something weird. For Microsoft, a copy of Windows XP is worth the CD. For us mortals, it isn't. It resembles number 2 on your list, but that would imply Microsoft being a monopolist which I thought it wasn't. For example, when there are only two suppliers of energy, one selling oil (=Windows), the other charcoal (=Linux), and you can be sure they don't have an agreement on pricing, I can't imagine one of them burning it to get a higher profit as people would switch to the competitor. Strange.

Slight nitpick: the coffee

Slight nitpick: the coffee growers in #2 suffer the same economic loss of labor and materials that the Fed does in #3. :mrgreen:

Microsoft does not have a

Microsoft does not have a monopoly on operating systems, but copyright law does grant it a monopoly on Microsoft Windows. Similarly, the author of any copyrighted work has a monopoly on that particular work, which allows them to sell copies at a price above the marginal cost of printing a CD or book.

You mention GNU/Linux, which has no monopoly distributor. Sure enough, you can buy GNU/Linux on CD for approximately the cost of materials and distribution. (Of course, you will have to pay more if you also want a support contract.)

One monopoly product affects the price of another only to the extent that it can be used as a substitute. If one filmmaker sold videos for a dollar, would you immediately buy those instead of more expensive videos by other artists? Switching from oil to coal may have some costs, but in most cases it is relatively simple. Switching from Windows to GNU/Linux would be both difficult and costly for many customers.

Alex, Thanks for your

Alex,

Thanks for your comment.

Slight nitpick: the coffee growers in #2 suffer the same economic loss of labor and materials that the Fed does in #3.

The coffee growers CHOOSE to burn their surplus crop. The past labor and material inputs are already sunk costs at the point of decision. Thus they are accounting costs, but not economic costs.

In the case of the presumably accidental Treasury fire, it is the future labor and material replacement costs that are of significance.

Regards, Don

Matt, You're right I think.

Matt,

You're right I think. Actually, Microsoft *is* kind of burning copies of Windows, by limiting the supply to (almost) exactly the amount they can sell at the best price. (it is very well possible that they actually do burn copies of old versions that didn't get sold because they set the price to high). (I won't comment on Microsoft's monopoly based on law as I'm still reading Kinsella about that :-))

Don,

I'm not sure about #2, could you elaborate on that? To the farmers, profits may be higher when they burn part of there crops, to "the people", it is a loss. I don't mean to make some utilitarian argument (who's to say someone is not allowed to burn his own crops), but it does sound a bit strange. I know it does happen, but why? It would mean that "the market" is willing to pay more (in total) for less products. I can't think of other reasons than transportation being too expensive at a lower price or that something can suddenly be sold as "exclusive" (like caviar). The market would act really strange if it is willing to pay more for less.

Joep, I’m not sure about

Joep,

I’m not sure about #2, could you elaborate on that? To the farmers, profits may be higher when they burn part of there crops, to “the people", it is a loss. I don’t mean to make some utilitarian argument (who’s to say someone is not allowed to burn his own crops), but it does sound a bit strange. I know it does happen, but why? It would mean that “the market” is willing to pay more (in total) for less products. I can’t think of other reasons than transportation being too expensive at a lower price or that something can suddenly be sold as “exclusive” (like caviar). The market would act really strange if it is willing to pay more for less.

No, that's not the way it comes out.

A monopoly supplier maximizes his profit by attempting to price so that Marginal Revenue is equal to Marginal Cost for the price/quantity demand curve that he believes he faces. If his Marginal Cost is zero, then the profit-maximizing price is equal to the revenue-maximizing price. If he attempts to sell more units than are demanded at the revenue-maximizing price, he must lower the price by a larger percentage than the percentage increase in the number of units sold. This results in a lower total revenue. This is, of course, what revenue-maximizing price means.

If his Marginal Cost is not zero, then the monopoly supplier's profit-maximizing price is higher than the revenue-maximizing price by roughly 1/2 the Marginal Cost. This is true for price/quantity demand curves that are linear above the revenue-maximizing price, assuming constant Marginal Cost, but since the demand curve faced is an educated guess at best, there is likely to be little justification for assuming anything other than a linear curve in the region of interest.

Regards, Don

"Actually, Microsoft is kind

"Actually, Microsoft is kind of burning copies of Windows, by limiting the supply..."

The traditional monopoly model makes exactly zero sense when talking about software. Microsoft does not limit the supply of Windows copies, indeed they cannot, because the supply is inherently infinite (w.r.t. physical resources, time is still a binding constraint). Take a Windows CD and copy the contents to your hard drive. Then copy those. Continue 'til your disk is full. Better yet set up a streaming server that continuously broacasts those bits out into the ether. The price of software is fundamentally disconnected from quantity, because it is not materially scarce.

Thinking about how software breaks the monopoly model should also remind us how poorly the standard models describe reality in any case. Monopolists do not in any case control the supply and allow the price to find itself, they set the price and try to sell as much as they can, which is indeed what all firms do.

Noah, Thinking about how

Noah,

Thinking about how software breaks the monopoly model should also remind us how poorly the standard models describe reality in any case. Monopolists do not in any case control the supply and allow the price to find itself, they set the price and try to sell as much as they can, which is indeed what all firms do.

If you replace the bold section above with 'at a level which is thought to result in the greatest surplus of sales revenues over forward costs', you would be correct.

Regards, Don

"Any additional examples ...

"Any additional examples ... would be appreciated".

I can't believe nobody's mentioned the Social Security trust fund bonds.

Happy New Year

Jim, I can’t believe

Jim,

I can’t believe nobody’s mentioned the Social Security trust fund bonds.

That was my #4, certainly a prime example of the species.

Regards, Don

"That was my #4..." Aw ...

"That was my #4..."

Aw ... How did I *not see* that??

Ah, I saw the words "Eliot Spitzer" and my brain short-circuited.

Sorry ... but he figures to be my next governor ...

Happy New Year Again, to make up for it.

The traditional monopoly

The traditional monopoly model makes exactly zero sense when talking about software. Microsoft does not limit the supply of Windows copies, indeed they cannot, because the supply is inherently infinite

Microsoft definately limits the supply of Windows copies. Otherwise, a sentence like "Last year Microsoft sold 100.000.000 copies" wouldn't make sense. Actually, they are not selling copies of Windows but licenses to use it, but that doesn't change the fact that Microsoft does limit the number of customers it licenses.

Don, I disagree with your

Don,

I disagree with your example #4. You have arrived at the semi-correct answer but for the wrong reasons. The government has no obligations to pay social security. It has been ruled that social security payments in no way obligate the government to provide any specific amount of compensation to the payee. Since there are no obligations they cannot be "impacted".

On the other had every expenditure the government makes affects it's ability to pay future claims to someone. This is true whether the payment is "worthy" or not. I really doesn't matter whether the government uses the special non-marketable securities, issues a different kind of security, borrows to spend, or just prints up new money.

I guess however it depends on what you mean by "ability to pay". I think you are being ambiguous in your definitions here. Do you mean absolute or relative ability to pay?

If without the expendature the government would have only been able to meet it's obligations then a future shortfall will occur in any of these cases and will either show up by paying the entitled less quantitative dollars, with depreciated dollars or by defaulting on the debt (and by defaulting I mean to include the payment of debt with depreciated dollars). Now by shortfall I do not mean an inability to pay.

Of course the possibility exists that the economy, independent of the government might grow at a rate that is unexpectly fruitious. In which case the government could meet its obligations regardless of how irresponsibly it acts. What I meant by "ability to pay" was a relative ability. Surely a billionare has a better ability to pay for a new low end car than your average Joe even though the car is well within the budget of the poorer fellow.

Even were you to use define "ability to pay" as the absolute ability your example would depend on other factors and so you could say for sure whether a particular payment would throw the government "over the line".

If the government does come up short in the future for social security then who is to say whether the problem was due to spending too much on patronage vs. too much on defense? The fact of the matter is that both types of spending affect the ability to pay on social security.

I think you are giving people the wrong impression with a couple of your posts here at catallarcy. I think you are not using precise enough definitions of your terms and examples and it is leading you to statements that although seemily true are actually false. I seem to recall some previous post on unfunded mandates where you made errors which were due to poorly constructed definitions and imprecisely specified conditions. What exactly is "previously existing construction industry" does it include manufacturers of construction materials or not? What do you mean by "damage". These ambiguities make your scenarios impossible to reply to. You titled that post with "Why Unfunded Mandates Cannot Be Effectively Funded in Advance". You know from the title and the contents I cannot tell what the heck you mean by an unfunded mandate. Isn't it an contradiction to call a mandate that is funded in advance an "unfunded mandate". Shouldn't perhaps the title of your article be "Why unfunded mandates are equivalent to funded mandates in their economic effects". If so then I would say you were totally wrong.

Firstly the costs of funded vs. unfunded mandates fall on different sectors of the economy. Funded mandates tending to fall on current taxpayers whereas unfunded mandates may fall on for instance on future taxpayers vs. creditors to some extent depending on how the government debt is liquidated. Who the costs fall on also depend on what extent they method of repayment is know in advance and the ability of the players to avoid the costs. So the first problem is who pays and it comes out of the payees pockets in the form of reduced consumption either now or in the future.

Secondly, the impact on the construction industry depends on what extent the producers believes some major project will occur. An unfunded future mandate is less credible and more of a gamble for a businessman to plan for. What is to assure the investor in say some industry that would profit from bridge construction to invest if no funds have been set aside. A firm construction start date and a big pile of funds for implementing the plan is certainly more attractive to the investor. Therefore a funded mandate is more likely to have the proper industrial structure once the date arrives.

You also did not factor in whether the government in question has a fiat currency, whether that currency was the world reserve currency, the reputation of the government, and a whole host of other factors that would tend to effect the outcome. It seems to me that you assumed a government in the position the U.S. has been in the past with a fiat currency which is a world reserve currency which is in a period of low inflation. This is a rare circumstance indeed. I say this because you seemed to assume the businesses plans would be equivalent for a funded vs. unfunded mandate. This situation will only occur where the businesses would have the same confidence in both situtations. This is not likely under a gold standard, and certainly not for a country that is likely to default because it has a non-reserve fiat currency.

Brian, Thank you for your

Brian,

Thank you for your comprehensive comments.

I disagree with your example #4. You have arrived at the semi-correct answer but for the wrong reasons. The government has no obligations to pay social security. It has been ruled that social security payments in no way obligate the government to provide any specific amount of compensation to the payee. Since there are no obligations they cannot be “impacted".

Yes and no.

As you say, there is no obligation created by the social security payments themselves, but there is at least an effective obligation either in existing law (even if no payroll tax receipts existed), or in future law which would be politically required to come into effect.

When the government borrows (and spends) the current social security surplus, there IS an obligation to redeem these trust fund notes at maturity.

Assuming that the Treasury sells new public debt to accomplish this, the political choice at the point when the trust fund becomes exhausted is either to abruptly step down social security payments to the level of payroll tax receipts, or to just continue the new public debt sales seamlessly just as if the trust fund hadn't become exhausted. I don't think that this would be a hard political choice to make even if there is nothing in the law that obligates social payments independent of payroll tax receipts.

I'll try to respond to the rest of your comment later.

Thanks, Don

Brian, I think you are

Brian,

I think you are giving people the wrong impression with a couple of your posts here at catallarcy. I think you are not using precise enough definitions of your terms and examples and it is leading you to statements that although seemily true are actually false. I seem to recall some previous post on unfunded mandates where you made errors which were due to poorly constructed definitions and imprecisely specified conditions. What exactly is “previously existing construction industry” does it include manufacturers of construction materials or not? What do you mean by “damage". These ambiguities make your scenarios impossible to reply to. You titled that post with “Why Unfunded Mandates Cannot Be Effectively Funded in Advance". You know from the title and the contents I cannot tell what the heck you mean by an unfunded mandate. Isn’t it an contradiction to call a mandate that is funded in advance an “unfunded mandate". Shouldn’t perhaps the title of your article be “Why unfunded mandates are equivalent to funded mandates in their economic effects". If so then I would say you were totally wrong.

No, I didn't intend to imply that the economic effects would be fully equivalent.

An unfunded mandate would be one whose future payouts would exceed its future receipts.

No matter where the future funding comes from, the bridge construction will result in its production factors being bid up and away from other employment, to varying degrees.

If I believe that my expenses in retirement will exceed my future income and savings, I can sacrifice current consumption to increase my savings. However, if I am and will be a master counterfeiter, then the current sacrifice is unnecessary. My future consumption demand will incrementally drive specific prices up whether I am spending savings or counterfeit bills. The government IS the ultimate counterfeiter. It has no reputation to defend at this late date and whether the dollars it spends are newly printed or are tax dollars that have been stored away for 50 years is of little import. Absolute price levels in general will be different but the economy largely runs on relative prices. The fact that the government may have contracted the effective money supply by taxation 50 or 1000 years ago does little to reduce the current effects of the increased buying power being bought to market now.

The 'damage' I referred to was the current effective monetary contraction brought about the current taxes.

The construction industry that collapses is, for example, the residential housing sector, to the extent that some of its production factors have been bid up in price for the bridge construction. It is forced to raise prices, reducing its demand below the level for which it has developed capacity. While the suppliers of materials will benefit by the increased demand and prices for their output, after the bridge is completed many of their original customers will no longer be in existence. This rules against a level of expansion in capacity that would be able to fully supply the bridge construction without raising prices.

Regards, Don