Part 2 - Money to share
First, we relate valuation and asset pricing to the natural dynamics of value in the real economy as developed in part I of this book (Time to value). This shows that we can relatively easily include the individuality of the risk-free rate (time value of time) into our current models of corporate finance and asset pricing. The well-known net present value formula (“Value equals free cash flow divided by the cost of capital minus expected annual growth”) remains unchanged, but the cost of capital now consists of (1) a premium for the inability of the investor to predict future growth (which reflects his individual exposure to uncertainty of expected future cash flows) and (2) a premium to account for the investors’ time value of time (which reflects the risk aversion of the investor).
Secondly, we relate economics and financial accounting to time accounting. It reveals that free cash flows (dividends) in the financial system generally flow to different people (investors) than free time flows (dismissals and labour reduction) do in the real economy (employees). Therefore, the people that receive more free time often do not have the income required to spend their additional free time as leisure. This leaves them no choice but to find new jobs and keep working equal hours. Consequently, (nearly) all productivity increases have always been reinvested in consumption growth instead of leisure time.
Thirdly, we develop the consolidated financial statements (P&L, balance sheet and cashflow statement) of a fictive merger of all companies and financial institutions (referred to as the “private sector”) of a closed economy with a certain Gross Domestic Product (GDP=C+G+I), wherein all companies and financial institutions are privately owned and the government does not employ people but sources all its services from the private sector (referred to as a “truly capitalistic closed economy”). By consolidating the private sector we eliminate all business-to-business transactions, which leaves us with all business-to-consumer transactions (commonly referred to as “C”) and all business-to-government transactions (commonly referred to as “G”). This way, we denote the consolidated financial statements of the private sector of a truly capitalistic closed economy in terms of the various components (C, G and I) of GDP.
From these consolidated financial statements we derive among other things the “net public budget constraint”. This is a numerical equation that expresses the development of the consolidated debt position of the public sector (all loans provided by the private sector to all governments and all households) in terms of the net interest rate (r), nominal growth rate (g) and fractions of the various components of GDP. The net interest rate is the weighted average interest rate paid on public debt minus the fraction that is regained by the public sector by (1) imposing taxes on the financial sector and (2) by labour costs and dividend payments of the financial sector. We then solve the continuous-time equivalent of this numerical equation assuming a steady state. This shows that our current financial system is unstable if the net interest rate is higher than the nominal growth rate of the economy, which is probably not the case in real-life. However, by decomposing the public budget constraint it appears that our current system of money creation (fractional reserve banking) inevitably results in both financial instability and an ever-increasing inequality between households. A policy of inflation, which most central banks have, accelerates these dynamics.
Finally, we give some guidance on how we could adjust our monetary control and inheritance taxing policies to develop a sustainable financial system that is both stable over long periods of time and reduces inequality between households. Part 2 of this book comes with a spreadsheet model that supports the content of the book and can be used to see the long-term impact of tax regimes, nominal growth rates, interest rates and fractional reserve banking on financial stability.
Summary - 1.1 Money has no value. Only time has
