Macro-Accountancy Primer

Get more educated. Primers are useful. Using finance and accounting-based principles, imagine a simpler and more accurate way to view and anticipate the behavior of the macroeconomy. This primer describes one of the added value proprietary methods used by Macroeconomics Review to better forecast the economy. Not just posted without explanation, the following lays out the development, logic, terms and usage of the first of eight proprietary macro-accountancy methods (formulas) used to predict periods of prosperity and recession.

Return to basic economics. After the massive failure of most economic experts to see the Great Recession coming, then happening and still slowly abating since leaving a fragile economy, renewed interest has surged in system dynamics, monetary stocks and flows, credit behavior, aggregate debt and national accounting methods. These simpler analytical mechanisms and naturally observable attributes of capitalism had been replaced over time mostly by theoretical economic assumptions and unobserved facts, beliefs in transparent dissemination of information and perfect knowledge of markets, overarching rational expectations, to disregard debt and the role of banking, prices and wages being both simultaneously fluid and also sticky, that unemployment and inflation were highly correlated and the like. Also mistaken, recessions were thought to be caused by unknown shocks to the expert’s economic equilibrium.

Learn what is real. Departing from the mainstream, the real predictors of the Great Recession relied more on accounting techniques to forecast the mess rather than economic models based on calculus and perfectly sloping crossing curves. It is now their opinion that all advanced degrees in economics should follow prerequisite under-graduate degrees in accounting. It turns out, all along, the entire economic profession should have been watching useful charts of cross-tabulated macro-accounting monetary factors and ratios.

Determine your fitness. For institutions and qualified individuals seeking strategic advantages in the real-world to better understand, review and help predict the macroeconomy for their respective purposes, this Primer is the first step to prepare the new subscriber/member to think in new economic terms and to use proven tools provided on this website. Unlike mainstream economics, they are mostly accounting-like. The ebb and flow of funds and credit money (mostly priced and produced by third-party creditors) coursing through all transactions in the macroeconomy can now be better understood in terms of their sources and uses of capital over time. This type of accountancy is more useful than recently disproven and debunked theoretical macroeconomic alternatives.

Understand the alternative discipline. Macro-Accountancy is the practice and study of macro-accounting or national accounting. This work does the collections, accounting and reporting of the total or aggregate economic mechanisms of a nation. Rather than financial accounting that looks at individuals or single companies, the accounting macro-view forms the basis for the official statistics that summarize a nation’s economic development and performance. The Bureau of Economic Analysis (BEA) and the Federal Reserve System (Fed) are leading providers of this economic data. These accounting figures are released to the public on a periodic basis, usually monthly, quarterly and certainly annually. Drawing upon that data, national sectoral statistics, economic indicators and total performances are prepared therefrom such as a nation’s gross domestic product, balance of trade, and total government debt and so on. For these reasons, such statistics are closely watched by many and varied market participants to assess a nation’s economic risks and performance to reduce market risks.

Understand the context. Macro Accounting and Financial Accounting have much in common. Accounting principles of one are natural principles of the other. Both can account for transactions and sources and uses of capital. Using money to score and settle business transactions in financial accounting, Periodic Sales (S) generate revenue from which periodic Expenses (X) are deducted to derive periodic earnings (profits; P), which adds to the eventual surplus income and net worth of the entity. As a source of new funds, profits add to the equity of the entity. Sales are an indicator of activity. Expenses are an indicator of preparation for the activity. Profits are an indicator of resulting well-being. Sales and Expenses are a better predictor of eventual Profits, retained or expended. Using the Accounting Equation, Assets (A) = Liabilities (L) plus Equity (E), e.g., A = L + E, the total shorthand equation for the foregoing activity-to-wellbeing expression is therefore: (S – X) = P, which Profits (P) are finally added to E of said equation A = L + E. As such, Assets therefore increased because Equity increased. Assets decline when there are negative profits (losses), which diminish equity. The equation is always kept in balance. The Accounting Equation was ultimately established as a commercial standard by Luca Pacioli, a Franciscan monk and associate of Leonardo da Vinci, who first published for general adoption the double-entry ledger system in his detailed mathematics textbook Summa de Arithmetica, Geometria, Proportioni et Proportionalita published in Venice in 1494.

Stand on a proven foundation. Given the above, having settled such transactions over a given period, sources and uses of capital can be measured through the various accounts. By re-arranging the accounting equation into a zero-sum proof, sources and uses of capital by the individual or entity or in the aggregate can be shown. As illustrated, a source of new capital is Profits. Another source of capital is the Equity owned by the entity or new equity contributed to Equity. Another source of new capital is new Credit or Debt (liabilities) added to the Equity and any new Profits of the entity to expand capital. All these capital sources can be aggregated to purchase new or additional Assets. L + E + P are generally sources of capital. Assets (A) of the accounting equation are generally uses of capital. Written together into the zero-sum proof, we have a balanced source of capital minus a use of capital: 0 = [(L + E + P) – A].

Adapt the knowledge. The accounting is the same for the macroeconomy. The macroeconomy at its grossest level of accounting is a myriad of transactions conducted between countless cooperating buyers and sellers with said transactions scored and settled at agreed upon prices using money as a medium of acceptable exchanges and recorded in ledgers. These numerous transactions exist together in crossing and parallel supply and value chains generating double, triple or more accounting entries for all participating parties completing exchanges in the milieu. One entity’s source of capital is another’s use of capital that facilitates a large successful set of interrelated transaction. Millions and millions of transactions creating billions and trillions of mutual value are accounted for daily—all triangulated and facilitated by the intermediation of money and credit money which is controlled by banks, which have the power to set the quantity and price (interest expense) of their acceptable tender. Promises to eventually deal with real money to settle the promissory transactions give rise to accounts receivable and accounts payable. These can be short-term promises or long-term promises to repay and settle the exchanges. This trade credit and lender credit allows transactions to proceed as if cash were tendered. With this accommodation based on mutual promises, we can invest now or consume now—and pay for it all later.

Apply the proof. As illustrated in the firm’s financial bookkeeping microcosm above, for macroeconomics, we also start with the aggregate P&L of the nation. Harken back to (S – X) = P. Mark Skousen, economist, has successfully argued that Gross Output (GO), the top-line of the nation’s economy, is not unlike Gross Sales (S) of an entity, that Intermediate Inputs (II) deducted therefrom are actually Cost of Sales (X) and that the resulting Profits (P) are tantamount to the Gross Domestic Product (GDP). In this market scramble, GO and II are double-or-triple or more accounting entries in all the interrelated supply and value chains of Production, which eventually resolve into the single-accounting entry of GDP. Like financial accounting characteristic, because of natural leading and lagging market mechanisms, activities and transaction preparations, Gross Output and accompanying Intermediate Inputs are a better predictor of eventual GDP than visa-a-versa. As a result, the BEA has formally stated that Gross Output minus Intermediate Inputs equal Gross Domestic Product. The equation GO – II = GDP is canonized. Since early 2015, these reliable national P&L-related figures are published quarterly.

Deal in actual content. If freedom of choice is pervasive and persistent, the three most important factors in understanding macroeconomic’s content and thus macro-accountancy are transactions, transactions and transactions. Buying and selling at agreed upon prices for mutual benefit is the ultimate transactional cooperation. More transactions are better than less transactions. Transactions generate inputs and outputs. One’s input is another’s output, which is another’s input being an output for another…and on and on, until there has been sufficient turnover with a sufficient amount of credit money and non-credit money in the input-output system to satisfy all participants with sustainable mutual gains, which is always and everywhere hopefully self-serving.

Substantiate the model. Being also a contemporary of John Maynard Keynes (1883-1946), the inventor/scientist economist, Irving Fisher (1867-1947), was first and best to explain this top-line transaction-based massive market mechanism. It is called the Equation of Exchange, which is also the basis of the Quantitative Theory of Money. He states that there is a quantity of total money with its aggregate fluid turnover (Fisher called it velocity) held and traded among many hands that accounts for the total value of the sum of the products of all transactions that were settled at prevailing prices for the quantity of goods and services exchanged over an accounting period. This macroeconomic idea came from his watching the maturing Stock Exchanges of that day with their analogous reported aggregate prices multiplied by aggregate volumes of trades. Fisher’s famous Equation of Exchange is given as: MV_T = P_TT. P equals prevailing market prices; T is the sum of associated transaction volume—or, price times volume. M equals the amount of total money that is turned over V amount of times, an aggregate velocity—the quantity of money times its then active turnover multiplier. All the factors are variable. Also, the Fed has shown that money velocity is not fixed, but also an independent variable.

Consider the data. The product of the factors on each side of the Fisher model are two enormous numbers that equal each other, which accounts for the broadest possible measure of total macroeconomic activity over a defined accounting period. In 1979, this author first noticed this interesting Gross Output correlation as a young research economist. Vernon Smith, a Nobel Laurette, Mark Skousen and a growing choirs of other financial practitioners have affirmed that Fisher’s Equation of Exchange is actually a nearly perfect substitute term for Gross Output—(GO), now defined by the BEA as the broadest possible measure of total economic activity in the production of new goods and services (not including used goods, transportation expenditures and most business-to-business transactions, which would make the number even greater) in an accounting period. GO is a much broader multiple-accounting measure of the economy than gross domestic product (GDP). GDP is a single-accounting measure of final output (finished goods and services). The BEA reported that GO reached over $33 trillion beginning 2017. For that total to happen, it is safe to say that there must have been a sufficient exogenous and endogenous supply of money in the monetary system to fully provision and accommodate the overarching GO mechanisms at that national production level or even higher (if the value of used goods, transportation expenditures and B2B payments were rightfully included in the entire accounting). Gross Output is also much more volatile than GDP also making it likely having higher money velocity scores. (The Fed calculates and publishes its money velocity factor by simply taking reported GDP and dividing it by reported M2.)

Embrace the extensions. Skousen currently publishes an Adjusted GO statistic to account for some of the missing gross output values. It needs to encompass more. Someday, soon, an all-in number will be published by the BEA….let’s call that future truly comprehensive total gross output number GO⁺, Gross Output Plus. On that day, there will also be an expanded companion term announced for all the fully comprehended concomitant intermediate inputs: II⁺, Intermediate Inputs Plus. This is because GO⁺ – II⁺ = GDP. Alternatively rearranged, GO⁺ = II⁺+ GDP. Or,

0 = [GO⁺ – (II⁺ + GDP)], a larger source minus two large uses.

Apply the enlightenment. The amount and velocity of total money to satisfy the transactional requirements of GO⁺ and II⁺ are likely larger than M3. M3 was a measure of the total money supply that included M2 as well as large time deposits, institutional money market funds, short-term repurchase agreements and other larger liquid assets. Now curtailed, this larger money measure was last reported by the FED in 2006. Since then, M2 is mostly tracked now. Nevertheless, Fisher’s Equation of Exchange can be better applied using GO⁺. Hence:

MV_T ≈ P_TT ≈ GO⁺.

Use the knowledge. This gross output and total monetary accounting method is focused on the utility of the aggregate exogenous and endogenous quantity of money in our macroeconomy. First formulated by the author in 1979 into the sources and uses configuration above using M3 and GO data, this double equation was the basis to establish one of eight propriety analytical forecasting methods for use by Premium Members of Macroeconomics Review mentioned above. Using other reported Fed and BEA data since 2006, new estimates and important predictive measures have been developed to better understand the stability and instability of the macroeconomy. It also gives a greater understanding of the not-so-small role and actions of financial institutions and their uniquely created and vended credit money, priced and supplied by their entire monetary industrial complex.

If this is new and useful knowledge, there is much more for PREMIUM MEMBERS.

Join us.

Jay Carlson, Editor-in-Chief