{"id":462,"date":"2016-10-23T23:30:08","date_gmt":"2016-10-24T03:30:08","guid":{"rendered":"http:\/\/commoncents.blogwyrm.com\/?p=462"},"modified":"2016-10-23T20:30:13","modified_gmt":"2016-10-24T00:30:13","slug":"bookkeeping-and-wealth","status":"publish","type":"post","link":"https:\/\/commoncents.blogwyrm.com\/?p=462","title":{"rendered":"Bookkeeping and Wealth"},"content":{"rendered":"

Last year around this time, I posted a column, entitled Candy and Wealth<\/a>, where I explored what is meant by wealth.\u00a0 The basic premise is that wealth is built on an individual level \u2013 that one man\u2019s garbage is another man\u2019s treasure.\u00a0 The mechanism for proving this was the candy game where a variety of candies were distributed amongst a group of children at random.\u00a0 Before any trading was allowed, the children were asked about their satisfaction level.\u00a0 After being allowed to trade amongst themselves, the children were again asked about their satisfaction level and, even though the number of candies had not changed \u2013 only their distribution among the population, the satisfaction level across the board had risen.<\/p>\n

\"candy-trading\"<\/a><\/p>\n

In other columns, the notion that no party ever trades with another for parity has been discussed.\u00a0 In a nutshell, suppose that A has n<\/em> goods and B has d<\/em> dollars and that A and B agree to a transaction that trades their supplies.\u00a0 The fact that n<\/em> goods were exchanged for d<\/em> dollars does not mean that the value of the n<\/em> goods was\u00a0d<\/em> dollars any more than it means that d<\/em> dollars can buy n<\/em> goods.\u00a0 A and B enter into a trade precisely because A believes that the d<\/em> dollars are more valuable than the n<\/em> goods and B, conversely, because he believes the n<\/em> goods are more valuable than the d<\/em> dollars.\u00a0 All trades work this way.<\/p>\n

And yet how do we reconcile these ideas with the price and going market rates and bookkeeping that we see perpetually and ubiquitously around us?\u00a0 Simply put, the price and market rates are the sensations or nerve impulses in society as a whole that send messages of pleasure and pain to the body politic saying \u2018do more of this\u2019 or \u2018stop producing that\u2019 and so on.\u00a0 Bookkeeping acts as\u00a0the collective memory of the previous transactions in addition to providing the required insight into entities such as publicly-traded corporations.<\/p>\n

In no way, should those two ideas be confused, but in almost all circles that is precisely what we do.<\/p>\n

Case in point is the book Double Entry: How the Merchants of Venice Created Modern Finance<\/em>, by Jane Gleason-White.<\/p>\n

\"double-entry-cover\"<\/a><\/p>\n

Gleason-White opens and closes her book with a lament about the inadequacy of the GDP.\u00a0 Her view is that the GDP is an \u2018all-important\u2019 number that sets world-wide policy about how resources are valued, produced, and consumed and by whom but which fails to take into account the really important things about life.\u00a0 To quote Gleason-White:<\/p>\n

Like many before and after him \u2013 including the GNP\u2019s creator, Simon Kuznets \u2013 Senator Robert Kennedy believed there was something profoundly wrong with the way we calculate our national wealth and with the numbers we produce to do so, such as the GNP and the Gross Domestic Product (GDP).\u00a0 As Kennedy pointed out, these numbers generate alarming anomalies: in their parlance cigarette advertising is worth more than the health of a child.\u00a0 And yet today, forty years after Kennedy\u2019s call for their revision, these numbers continue to rule the policy decisions of governments, financial institutions, corporations, and communities. These flawed numbers rule our lives.<\/div>\n

I actually think she has a point here; that is to say that I agree with her conclusion.\u00a0 Unfortunately, I don\u2019t agree with her argument that supports this conclusion nor do I agree with her solution.\u00a0 The reason being that she spends much of the book conflating the monetary value exchanged during a transaction with wealth in much the way I discussed above.<\/p>\n

Central to her storyline is that the origin of these flawed numbers lies squarely with the invention and promulgation of double-entry bookkeeping<\/a>, a feat of which\u00a0she attributes the central role to a medieval monk by the name of Fra Luca Pacioli.\u00a0 For those who don\u2019t know, double-entry bookkeeping is an accounting method whose inherent\u00a0structure error-checks financial and capital transactions into which\u00a0any enterprise enters. \u00a0It is sort-of a monetary checksum whose \u2018balance\u2019 assures that no gross mistake has been made.\u00a0 It is to economics like what recorded measurements are to science; it is a way of keeping track.<\/p>\n

There are many fine sources on the internet for examples of double-entry bookkeeping (my favorite is Accounting-Simplified.com\u2019s treatment<\/a>) and, while the concept is straightforward in theory, the intricacies can be difficult in practice.\u00a0 The situation is made more difficult by the fact that the particulars differ a bit between cultures.\u00a0 I\u2019ll be focusing on the so-called Accounting Equation Approach, but all the methods have the same general feature.<\/p>\n

The core concept in double-entry bookkeeping is that every transaction must have two accounts into which it is recorded \u2013 what I will call the \u2018to\u2019 and the \u2018from\u2019 account.\u00a0\u00a0 It is much like a physics problem where energy or momentum of two colliding billiard balls is tracked.\u00a0 The gain in energy or momentum in one system is offset by an identical loss in the other, since energy and momentum are conserved.<\/p>\n

For example, suppose I buy a computer and I pay for it with cash.\u00a0 To the untrained mind there is one transaction: the purchase of a computer.\u00a0 But under double-entry bookkeeping, there would be two accounts involved (thus double the entries).\u00a0 In the first account, I would add a debit to the assets account to show the acquisition of the machine and I would add a credit to the cash account to show the payment of money.\u00a0\u00a0 The double-entry record would then look something like:<\/p>\n

\"computer_buy_double_entry\"<\/a><\/p>\n

There is some \u2018arcana\u2019 (at least to me) as to when something is a debit versus a credit.\u00a0 This is where the Accounting Equation Approach gets its name as the following mnemonic (it\u2019s not really an equation)<\/p>\n

Assets \u2013 Liabilities = Capital<\/p>\n

with debits having the following effects:<\/p>\n