The Economy, the Human Body & System Flows

The economy is essentially a system of flows.  Someone spends, another person earns this income, this person invests, the recipient spends and the cycle goes on.  When the cycle of spending dies the economy essentially dies.  Income’s decline, profits dry up, output goes unsold, workers get fired, etc.  It’s very similar to the way the human body works.  The human body is largely based on a system of flows.  As long as the blood flows the body receives the nutrients necessary for survival and every day operation.  But the flow is not necessarily enough on its own to sustain the system.  The system must be properly nourished and taken care of.  A human being who sits on his/her couch every day eating pizza is likely to experience an interruption in this flow at some point as the system deteriorates in health over time.  And when the flow stops (for whatever reason) the system dies.

In the economy, the “health” of the system is based largely on how this flow results in an improvement in living standards over time.  Are the economic agents using this flow to create goods and services that improve the overall standards of living for the system as a whole?  The “sitting on the couch eating pizza” equivalent for the economic system is a system in which the economic agents are unable to find productive uses for this flow.  In this scenario living standards stagnate, the flow stagnates and the system deteriorates.

One of the more important developments over time has been the understanding that humans have powerful tools that can sustain the flow.  That is, we understand (well, some of us at least) that the human body does not merely fix itself.  Sometimes it requires external aid in the form of modern medicine.  The economy is no different.  It does not merely fix itself at all times.  And we have developed powerful tools that can, at times, help (and, like modern medicine, can even be abused or misused).  I’ve often spoken of government deficits as one tool that can help.  Using this analogy of a system of flows, we can see that there are times when the flow slows or even stops (as it did in 2008).  When the flow stops the system is at risk of collapse.  A bit of modern medicine can help.  How can this be?  Isn’t government something exogenous and evil?  Well, it certainly can be if it is abused or misused.  But it can also be a very powerful tool created by us and for us.  In the recent crisis, for instance, when the flow stopped (i.e., incomes declined, revenues declined, output went unsold, workers got fired) there was only one entity that could step in and turn on the flow.  The government, in this regard, operates like an artificial heart.  It can ALWAYS procure funds from you in the process of taxing or selling bonds and essentially redistribute funds through the system.  In other words, it can increase the flow at critical times when the flow slows or stops.

But don’t get me wrong here.  The flow does not equal an increase in living standards per se.  That is primarily up to the economic agents who utilize this flow in certain ways.  Will they sit on their couches eating pizza or will they create goods and services that create a virtuous cycle whereby the flow sustains itself and the need for the artificial heart is reduced?   We are living in a period of great economic turmoil where we have powerful tools that can help.  Tools we have built over decades of debate and even death.  And we’re afraid to utilize these tools because we have fallen into the trap of believing economists who essentially pass their “modern” models off as the medicinal form of “if he dies, he dies”.  The human body, and the economy, does not always fix itself.  There are times when we can use the powerful tools we have created to help steer the body back towards full health.

Currently, the flow remains abnormally slow.  The body has partially recovered from its near-death experience, but we remain paralyzed by fear of becoming something we are not (Greece, a currency user).   We can increase the flow in various ways depending on your political preference (lower taxes or higher spending).  But the simple fact is this – we still need the artificial heart to sustain this flow as the private sector continues to de-leverage, spends below historical average and output goes unsold as a result.  The biggest risk we still face is turning off the spigot at a time when the private sector has not yet returned to full health.  And if the system dies or becomes sick again as a result we have no one to blame but our “modern” doctors who continue to push the idea that the human body is a self sustaining system that never requires external aid.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • no_economist_fortunately

    The best post I’ve read from you.

  • Tbill

    And we call this flow, the velocity of money.

  • Colin, S.Toe

    ‘Our “modern doctors”‘ are more like the medieval variety, whose only tool was bloodletting regardless of what ailed you (cf ‘austerity’).

  • quark

    The economic body/system is made up of cells. Through the bodies age some of these cells naturally turn cancerous. By nurturing the body with the proper foods and excercise, the growth of blood vessels to the cancerous cells is inhibited while blood vessel growth to healthy cells is promoted.

    Our economy is aging, the body has eaten as if McDonalds was the only food of choice and sitting and sleeping on a sofa has become a 24×7 occupation.

    The body has become dependant on a poor food supply and no excercise…prognosis is the cancer cells have metastisized with and the prescription is for more trips to McDonalds.

  • The Undergrad

    “There is no such thing as a velocity of money.” -Ray Dalio

  • jaymaster

    That’s a keeper! Great job.

  • http://www.pragcap.com Cullen Roche

    Witch doctors. Most of them….

  • LVG

    Powerful analogy. Nice job Cullen.

  • REN

    During depressions money becomes scarce, so it is like the body becomes starved for fuel. In a debt deleveraging depression scenario (BSR), adding fuel makes the body rev up and produce, rather than having its engines sit idle. Adding fuel to body helps it flow and makes a lot of sense in the right conditions. The converse is spending improperly, which does not do a body good.

    But, if the body is already overheating, then adding more fuel makes it inflate.

    Velocity does matter…big time. When money stops flowing, we humans want it to be an asset. When its flow is proper we want it to be “veil” or counter to mark our output. Silvio Gessel’s book, the “Natural Economic Order,” makes velocity maximum by having money degrade with tax stamps. This money experiment was actually carried out in Europe, proving the maximum velocity “veil” to be the case.

    Keen’s models show velocity factor to be 3.1 in a normal economy. So, the blood flow rate has a large impact, or 3.1 times the money supply volume. (If a comet vaporized your town center, would you rush out to make a loan to your neighbor? No, you would hoard your money causing economic contraction. Freaking out has the same economic impact as a depression, where money is not being created by the banking bone marrow.)

    Personally, as an engineer, this flow or “circuitist” method is how I look at it – a dynamic living system that has numerous feedback nodes.

  • http://www.pragcap.com Cullen Roche

    This is a great analogy thanks to you. I particularly like how it meshes with the view that a government can facilitate growth, but isn’t the driver of growth. Love it.

  • http://www.pragcap.com Cullen Roche

    Sorry, this was a reply to LVG.

  • LRM

    I think this recent Capital Account has some content applicable to this topic.
    http://www.youtube.com/watch?v=iquemUNNYY8&list=UU8eFERtcxPZ-M3Cxkh7zhtQ&index=2&feature=plcp
    If it was posted previously then by all means this can be removed.
    I felt on listening to this that a lot of what was said supports CR.
    In the end, he felt that the eventual outcome will depend on proper fiscal policy response.
    The only questionable response was that he thought that the USA by following the Japan model would eventually end up like Greece which was a surprise given the discussion previous to this statement.
    I think the show is worth while and want to find out more about the guest

  • http://www.conventionalwisdumb.com Conventional Wisdumb

    Cullen,

    I have always wondered about your thoughts on the 1920-21 depression during Calvin Coolidge’s admin and the lessons you would draw from it.

    During that deflationary depression, Silent Cal, cut taxes and cut government in half more or less and there was a quick rebound in the overall economy which lead to the “roaring 20’s”. This was in contrast to the actions of Hoover and FDR as chronicled by Amity Shlaes in the “Forgotten Man” where they both did the opposite – increased taxes and increased government spending.

    Did the economy behave differently because of the gold standard?

    Was it something else?

    Thanks.

  • EconFan

    good analogy. which is why tax cuts for lower incomes are much more productive – the money is more likely to get spent on real goods and services. And why the growing inequality is bad for the rich as well.

  • http://www.pragcap.com Cullen Roche

    I have talked about that actually. Only in comments though. This is a really popular austerity myth. The thing no one ever notes in the 20’s is that there was a HUGE credit boom. It’s actually a lot like the late 90’s. Clinton ran a surplus and then we had a small recession followed by a big credit boom. The weakness in the underlying balance sheets was masked by the credit binge. Once the credit binge stopped the economy crashed. Just like 1929 and 2008.

  • Edmund

    I’d add a bit to Cullen’s response – the recovery has been overly touted. Depending on what statistics you’re looking at (because there are different estimates), the recovery from that recession was either okay or not great. The Fed dropping the discount rate from 7% to 4% helped end it and fuel the credit expansion of the 1920s.

    Another way it looks a lot like the 90s or 20s is that although some measures of real per capita income rose rapidly, wages did not rise commensurately. Much was skimmed up by the very wealthy and everyone else supported the expansion by going into debt.

  • Greg

    Ive always liked the cardiovascular system metaphor for understanding the economy because its the CV system that I work with and manipulate every day in my job. Another reason I think this metaphor works is that while the heart (supplier) seems to get all the attention but its actually the cells (consumers,workers) that drive the system. The heart takes signals from the cells in the form of neural reflexes and hormonal and other chemical reflexes (like acids building up in muslces say) Its these signals which tell the heart when more supply is needed. States of shock or infection will affect the flows from the heart but its the heart meeting the needs of the cells not acting as some sort of “blood creator” who out of the goodness of his heart provides the cells as long as that central planning brain stays out of the way.

    I think there is real potential to distinguish between supply side thinking and demand side thinking too with this metaphor

  • Austin

    Too many financial leeches can suck all the blood from a body, thus eliminating any ‘flow’.

  • Kobayachi

    So our patient fell off a cliff because he was high on credit cocaine.
    Too bad there is no doctor available, they all have been hired by the private clinic on Wall Street.
    Thank god we have some nurses still around to give him some blood transfer (QE) and hook him up to the machines (algo trading, Libor manipulation).
    How long can we keep him alive with this huge gaping (speculative, derivative) wound?
    Somebody needs to talk some sense into this guy, cocaine is not food, my friend! Similarly, a bet or gambling is not the same as an investment (talking to you Jamie dimon).