Invisible Hand – Chapter Thirty-Five: Return of the Fat Man

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In which the supply of demand is fedback, looping unstably… Or something like that.

Niall came into class on a wave of mixed emotions. There was still the warmth of being accepted for himself, warts and all, from the night before. There was a sense of triumph for what he had thought out this morning about supply and demand. He also had some anxiety about how his ideas would be received, not only by the instructor but also by his friends. Now he was becoming worried about offending them by pointing out the flaws in their utopia.

This time he made it a point to sit in the front row, since he expected to be doing a lot of talking and he didn’t want the rest of the class to have to crane their necks to see him when he spoke. Once seated at the end of the row, he wondered if anyone else in history had ever concerned themselves with such a thought before. His emotions now had an overlay of feeling himself to be a little strange, on top of all the other feelings.

On this occasion the instructor was preceded into the classroom by the recliner on its dolly and followed by a small portable table with what looked like a variety of snacks and several bottled drinks, none of which appeared to be alcoholic. He settled into the chair, carefully selected a snack and took a huge bite, then chewed slowly, looking around the room as if they were all there only to eat. Having swallowed, wiped his mouth, and poured a drink from one of the bottles he glanced at the clock and said “Let us begin.

As I warned you last time we will today concern ourselves with the way supply and demand relationships shape the Payer organization and its actions. I assume that you all have given considerable thought to this relationship.” The members of the class glanced quickly at each other, remembering what they had been thinking about both last night and this morning at breakfast. “Therefore, I will limit my opening remarks to a few general points and expect you each to contribute to filling in the detail.

‘Supply’ refers to goods or services available for exchange. ‘Demand’ refers to the price people are willing to pay for those goods or services. In order to talk about supply and demand, therefore, we need to be explicit about what the goods or services are and about how the price is measured. You will note that ‘price’ is always expressed in terms of a money. This will be true even when the goods that are referred to by ‘supply’ are monetary units, or monies.

Supply and demand is a specific instance of what more generally can be called feedback. For example, our hands report what they sense to the brain. If the object being touched is hot or cold or sharp, the brain may have the hand pull back or drop the object. If the object is warm or smooth or soft, the brain may have the hand increase the touching.

This is a case of simple feedback. But there is also what one could call dual feedback or a feedback loop in which two agents give feedback to each other. Nature is filled with feedback and there exist many feedback loops of incredible complexity in the ecosystem. Human beings have recognized feedback loops in many ways. The concept of punishment for behavior we don’t like, for example, is an attempt to provide feedback in the expectation that such feedback will result in a decrease in the unwanted behavior.”

Mr. Sharpe was beginning to smack his lips again so he paused and addressed his interest to the partially eaten snack just before him. After a couple of bites and another few gulps of soda (perhaps a third of the bottle) he continued.

“Economists have noticed a particularly interesting form of feedback in market activity in the relationship between prices and the supply of goods of various types. Therefore we talk frequently today about supply and demand when we discuss economics.

The relationship between supply and demand in economics seems to assume that there exists a free market. Of course, in POM economies that’s almost never true. There are almost always governmental or other agencies which intrude into the market. But the tendencies and influences of supply and demand exist even in the absence of a free market. They are so powerful that they will always create a ‘black market’ whenever some agency attempts to prevent or resist their influences.

Therefore, it would be foolish of us to assume that there is no feedback in our economy. It would also be foolish to assume that there are no feedback loops. So we will assume that there are some. My first question is ‘What effects can feedback loops have on a system?’”

Dead silence was the response. Worried glances passed among the class members and then a lot of people were looking down at their desks so that the instructor saw mostly the tops of heads. Needless to say, Mr. Sharpe took advantage of this pause to refill his glass as well as his plate.

Niall thought, ‘I sat up front to talk so I had better say something.’

“I think they could be either stabilizing or destabilizing. That is, I can imagine supply and demand keeping prices and supplies stable but I can also imagine a feedback loop generating instability.”

“OK. That’s a start. Now what characteristics would you expect a feedback loop which was generating instability to have?”

“I know. If an increase in one factor caused an increase in another factor which caused an increase in the first factor,” Natalie said. “Like before WWI when each nation’s mobilization convinced the other nations that they were going to attack and then, to get an advantage, one of the nations attacked first, since it was obvious that the other nation would attack anyway.”

“Or like a disagreement between a husband and wife can escalate as each shows signs of anger which make the other person angry too, and before you know it they’re yelling and throwing things.” Oscar said.

“Those are good examples,” the instructor said,” but can you give an example from economics?”

“The Great Depression is an example,” Leyden said. “When the economy slowed in the United States after the 20’s boom, a few banks failed. This contracted the money supply, so more banks failed. The process continued back and forth, resulting in a deflation and joblessness. It took years to get out of that mess.”

“Germany after WW I had runaway inflation.” Clayton put in. “They just kept printing larger numbers on their bills. I think it had something to do with the war debts.”

Niall said, “When employment falls, income and spending fall. This results in lower sales. This results in less demand. This results in more layoffs and less employment. You can even express that one in terms of supply and demand. As demand falls, the supply falls and since the demand is a function of the supply through wages, which are another supply and demand relationship, the demand falls again.” ‘Damn, I was almost incoherent on that one,’ Niall thought, his face warming. ‘I’ll have to do better or sit quietly in the back.’

“Good enough, people,” said Mr. Sharpe, plying his napkin. “If the causal relationship is positive for both factors or negative for both factors, the relationship will be unstable. If the relationship is negative for one and positive for the other, then the relationship tends to be stable. If a reduction in A causes a reduction in B and a reduction in B causes a reduction in A there will be instability. If a reduction in A causes an increase in B and an increase in B causes an increase in A then you tend to have stability. Now can you give me examples of stability produced by feedback loops?”

“A thermostat does that. If the temperature falls, the thermostat increases the heating. If the temperature rises, the thermostat reduces the heating. Of course you reverse that with cooling,” D.W. said.

“Clouds increase when the temperature gets higher and that decreases the amount of sunshine getting to the Earth which allows things to cool,” a contribution from Natalie.

“Anything from economics?”

“Didn’t they try to set interest rates higher or lower to keep the economy stable?” Oscar asked.

“Yeah, but it didn’t work all that well. The economy was so dependent on what was happening in the rest of the world that they really couldn’t control it,” Leyden said.

“Doesn’t the POM free market keep both prices and supply stable?” Niall asked and tried to answer his own question. “After all, an increase in supply lowers prices and a reduction in price lowers supply. That would be an inverse relationship between supply and price when supply is doing the causing and a direct relationship between price and supply when price is doing the causing. We should be able to explain all the cases in which the market is unstable (that is inflation or deflation) as a result of the interference of the government and monopolies and such. That is, if the market isn’t free, it can’t function to maintain stability.”

“What about when supply is reduced due to natural causes like a drought reducing agricultural production? The dust bowl of the 1920’s had something to do with starting the Great Depression,” Natalie pointed out. “Wouldn’t that start one of the unstable feedback loops? And wouldn’t such a loop have a big effect on supply and demand?”

“But the Great Depression was caused by government intervention in banking and such, not by the dust bowl, according to my father,” Clayton replied.

Natalie came back with, “Small banks are very dependent on local conditions. If a small bank in a small town has lots of loans out to local farmers and local businesses that depend on those farmers and to local people for home loans, it would be very simple and highly likely that a drought that affected the farmers would also ruin businesses and people would lose their jobs in those businesses and not be able to make their house payments. With all those loans defaulting at once, the bank could very easily go under. That would make things even worse because a lot of local people would have lost their money.”

Oscar said,” I think the POM free market is only a stabilizing force when conditions are relatively stable anyway. I think it can be overwhelmed relatively easily by governments and monopolies and wars and droughts and such. I think it’s too dependent on the proper conditions to be robust.”

“Class,” Mr. Sharpe said coming up from a long drink of what appeared to be root beer. “You are all making good points. But we need some factor that explains the relative stability of our economy in comparison with the POM economies.” Then the instructor settled back in his chair and selected another grape.

Natalie said, “I think it may be because in our economy some of the POM feedback loops are broken. For example, in a POM economy, when people stop buying a certain item, the producers of that item lose their jobs. Therefore, they lose income and stop spending as much. This causes others to lose income and so on in a negative loop that’s destabilizing. In our economy, if an item stops being used, it doesn’t affect the amount of money being paid. If the items are luxuries, there’s still money to buy them and such excess money doesn’t cause price changes for the other luxuries, so there’s no loop there. If the items people aren’t consuming are necessities, then they must be surplus and we should stop making them, so it’s appropriate to stop producing them. If the items are capital goods, then we’re doing fine without them so they should no longer be made. Therefore all the destabilizing loops that might cause trouble in a POM economy don’t function in our economy.”

Leyden said, “Didn’t Mr. Sharpe just say that there were feedback loops in our economy and in the Payer organization?”

“Yes, Leyden, he did,” Natalie replied, “but those only involve money in one direction, not both. That is, since only the Payers can pay, the people they’re paying can’t give the money to someone else in some other feedback loop. Therefore, the feedback only involves money in one direction, from Payer to producer. Whatever feedback comes to the Payers as a result of their payments isn’t in the form of money. In a POM economy, a change in movement of money generates feedback that’s also a movement of money. Since POM money is independent of the goods for sale, there’s nothing preventing a wild oscillation.”

“Very good, Natalie.” Mr. Sharpe was actually smiling. “In most of my classes no one gets that aspect and I have to explain it. Now, does anyone have any other factor that might provide stability?” and he took a particularly beautiful cupcake and carefully, almost tenderly, began pulling the pleats out of the cup.

Clayton sat up suddenly, “Haven’t they been telling us that three-party interactions are more stable than two-party interactions? The fact that there are three parties to all our money transactions should make them more stable. In a POM economy, if you get an advantage you can use the money that advantage generates to get still further advantages. Like when a successful business uses its money to buy lobbyists to get legislation to give them still more advantages.”

“Yes,” Leyden said, “and when the people at the bottom stop having money to spend, it starts feedback loops that cause the whole economy to slow down. Since the wealthy and powerful are in control, they let hardly any money into the hands of the poor and things keep getting worse until the whole thing falls apart.”

“It isn’t that simple, Leyden but that is the general idea,” Mr. Sharpe said, grinning.

“What is so stable about the three-party interaction?” D.W. asked.

“Well,” Oscar replied, “the one party dominates another party and that party dominates a third party and that third party dominates the first party. No one party can dominate both the others. That way they can have mutually rewarding interaction indefinitely. In our case, the Payers dominate the producers by controlling the money. The producers control the consumers by determining what is produced and who can have it. And the consumers dominate the Payers because the Payers live among them and need their social rewards. Each group is kept from taking over by the group that dominates it. It’s like the old game of rock, paper, and scissors.” (Click here for an illustration of this concept)

“So,” Niall said, “though external forces may limit or reduce production, there’s always a money reward for benefiting others. The flow of goods and services from producers to consumers (and Payers) is matched by a flow of money (and luxuries) to the producers. Therefore, a lack of money is never the reason that something worthwhile cannot be done.”

“Class, you have resolved too many issues too quickly so you’ll have to endure a lecture.” With this announcement, Mr. Sharpe pushed aside the litter of empty containers on the table in front of him.

“You are correct that it is the breaking of the destabilizing feedback loops that makes our economy more stable than the POM economies. You are also correct that the three-party nature of the basic economic relationships keeps any one group from dominating the economy. You can see these influences at work in the payer organization. Most of what you will do as Payers is collect and share information. There will be others to help you with this but since you’re the ones who’ll suffer from failure in this data collection, you’ll want similarly motivated people to gather the data you need. This data is the feedback you’ll use to make decisions about payments.

Your motivation for wanting things to go smoothly, making the general public happy is that only then will you get the respect and attention that you crave from the public. Your experience of how people treat you and what they complain to you about will keep you on the proper path whether you like it or not. This is another source of feedback to you. This feedback serves as your conscience. It will be as good as the public is good and as bad as the public is bad. If you allow the shortsighted, fearful, irrational demands that will be made upon you to control your actions, you’ll suffer in the longer term. If you stand firm and do the right thing despite the foolishness of your friends and acquaintances in the public, it will do you no good because most of the other Payers will give in to it. The public will get what they deserve. But if they suffer, even though they’ll deserve it, they’ll make you suffer too.

So what can a Payer do? Alone she can do very little. That’s why the Payers must cooperate. That’s why it’s so important that anyone who wants to be a Payer can be one, at least for the time being. The Payer organization must be diverse or it will listen to only a little of the feedback it needs. It must be diverse or it will think of only a few solutions to the problems that the organization will inevitably face. It must be composed of freely cooperating people or its decisions will become ignorant and foolish. So what you can do is do what you must do. The system will make you do the right things whether you will it or not. The system will not pass a law or hold a gun on you. It will not threaten you with a fate worse than death. But you will find the system almost irresistible because the feedback you get will entice you, it will scare you, it will inspire you, it will tempt you, it will act upon you in ways you are not yet even aware of, and that’s good. If you could resist the system, you could destroy the system just as the system will destroy itself if it ever fails the society.

So don’t worry too much about having to be right all the time. Do the best you can and sleep peacefully because you don’t have to be perfect for everything to be okay.

Now that you have an idea of how the Payer organization is controlled and shaped and kept in line, let’s look at how it manages to do its job. Let’s look at the techniques it uses to do its part in the smooth functioning of the economy.

The first thing is allocations of resources. We’ve pointed out how the organization and its decision-making apparatus is influenced by free market forces and the various feedback loops. But how are the actual decisions made that determine who gets to use what resources and to what ends?

My first question is, who makes the allocation decisions in a free market economy?”

“Nobody,” some people said and the others said, “Everybody.”

“Correct. The market interactions, those beautiful and terrifying feedback loops, make the decisions. No they aren’t people, they are processes. But the results of those processes are the same as if some incredible and nearly omniscient super-mind were making the decisions. The amount of information being processed in those millions of free market decisions is prodigious and the result is distributed computing at its best. In this way the resources of the society are allocated by those who own those resources. Each person is trying to do what will generate the results they desire. In so doing, they gratify the needs and desires of others.

Now tell me some examples of this process with respect to particular resources.”

Leyden’s hand shot up, “Labor is a scarce resource. Those who are not very good at a particular task get paid little for doing that work, so they are motivated to move on to something else they can do better. In this way people tend to end up doing the things they do best.”

D.W. was next, “As the supply of a particular metal is reduced, the cost to the society of using it in products increases and therefore the rewards to those who employ it are reduced. This provides a motivation to use other materials in its place or other products to perform the same functions. The result is that the use of the hard-to-find metal is reduced.”

Niall, thinking that he had better say something or be left out of the class discussion he had thought he was going to dominate, said, “There are many kinds of breads made from a variety of grains. If people prefer certain grains and certain breads, those will be consumed and there will be unused breads and grains of those not preferred. Therefore, those who produce those grains and breads will be paid less. They will shift their efforts toward the more popular breads and grains. Thus the market will influence the amount of land planted in those grains and the amount of each kind of bread being made.”

“Who makes the decisions as to the ores and grains and breads?” Mr. Sharpe demanded.

Oscar said, “The owners do. If anyone else did, they’d be operating with less information and likely also with less motivation to make good decisions.”

“What if an owner makes a bad decision?” Mr. Sharpe asked with a raised eyebrow.

“He doesn’t get paid and people are reluctant to cooperate with him,” Oscar replied.

“Wouldn’t that bad decision wreck the economy?”

“No, because no single owner owns a very large part of the ore, grain, or bread,” Leyden said.” This is true of all the material resources. At most, a given individual might own one percent?”

“Why can’t one person corner the market on some resource?”

“I know!” Natalie squeaked. “Because capital is given, not bought. It’s the people who control the resources that own them and no one person can control very much of any resource.”

“Therefore,” Oscar said, “resources are allocated by everyone who owns or controls a resource. The process by which the society allocates resources is the free market.

“What do the Payers make decisions about?”

“How much net benefit was accomplished and who should get credit for it.” Wendy said.

“What else do they decide?”

“What things are to be called luxuries.”

“Anything else? What about how resources are to be used or where to place roads or where buildings should be built?”

Niall said, “Payers don’t make those decisions. They only observe and judge. They have no authority over anything except paying.”

“I think you’re ready to serve as apprentices now. Class dismissed,” Mr. Sharpe said almost in benediction and raised his hand accordingly. “Reggie!”

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