CCCXVI – The World’s Big Bath

I was talking to Hambone about something unrelated and he made a remark which would probably sound shocking to the uninitiated or the uncynical. Hambone and I went to undergrad together and become acquainted due to being in many of the same classes together. We then briefly worked at the same auditing firm together, before parting professional ways. So for context, both Hambone and I are accountants.

“As accountants, we should know that the numbers are all [garbage] anyway. It’s all grift.”

Be very cautious if you take up this line of thought. Many people wield it imprecisely–you might be tempted to think that “Corporations make up numbers”, which they do not. That’s the great thing about accounting: None of the numbers are made up. The numbers are all accurate inputs into an algorithm that churns out results that match expectations. The Accounting Algorithm can only do so much, it cannot make a bad company look profitable, but it can exaggerate mediocre times or mask exceptional times. Corporations do this for a variety of reasons. Auditors exist to make sure that the Accounting Algorithm doesn’t produce results that are too dramatically different from the real inputs, and in many cases are just looking to make sure that this year doesn’t look too different from last year. When times are good, this process works great. When times are bad, they tend to be REALLY bad, and take auditing firms down with them.

The headline that stirred up this line of thought in me was this one, from my Ukraine War source: “World Bank Warns of Global Recession“ caused by the war in Ukraine.

There is an illegal accounting technique–a technique that has been forbidden from Accounting Algorithms–called the Big Bath. The Big Bath is when a firm takes all of their losses all at once, so that the rest of the year looks good by comparison. “Man, there was a hurricane so Q3 Earnings were terrible, but look, Q4 showed huge growth year-over-year!”

There are signs that corporations are already contemplating this. I saw a headline somewhere that said a certain company was forecasting low earnings for Q1 reporting since the war in Ukraine began in February. Other tech firms have been committing layoffs. The sanctions have disconnected Russia from the global economic order and many corporations are terminating their operations there.

There is a discrete and definite impact of all of this on the individual firms and on the economy writ large. But if everyone starts reaching for the excuse “But the War in Russia!” then a Global Recession becomes more than just likely, but becomes certain.

This applies to more than just corporations too, it’s important to note. Governments control the levers of their economies. Debt and taxation have risen to terrible and drastic heights, and being able to take a “Big Bath” in the form of an economic collapse–and being able to blame it on Russia— probably looks like an appealing prospect.

Down that road leads war, unless some other path is taken. A global scale economic collapse with Russia as the scapegoat would create cultural animosity that can’t help but explode. I pray this is not the outcome, but it is hard for me to claim that it is something our politicians would not do even with full knowledge of the consequences of their actions.

The good news is that if we do undertake a global economic reset, there will be no bailouts because there will be no global economic system to rescue anyone. We will be forced to have an economy based on productivity and value, at least for a while–and only the productive and valuable will keep the economic dynamo running. It will be a healthy thing to drain the bad economic humors. We just have to make sure that what replaces it isn’t the same thing we had before.

AMDG

CCLXVII – A Jumble of Thoughts on Currency

I finally found a good primer from Zippy regarding currency as Tax Vouchers. I decided to turn my accounting brain to the task of what it would take to create a balance sheet for the US Government. The answer I’ve arrived at feels like cheating so I invite a thorough critique from any and all readers.

The problem with fiat currency–I will call them fiat vouchers form hereon out to avoid confusing myself–started (for me anyway) with thinking of the creation of the fiat vouchers themselves.

Primer: DR = Debit, CR = Credit

Imagine the accounting process one follows when creating widgets. First, you buy the raw materials with cash: DR – Raw Materials Inventory (RMI), CR – Cash. Second, you process the raw materials into finished goods: This is an entry in two parts. Part 1, DR – Finished Goods, CR – RMI. Part 2, DR – Work in Process (WIP), CR – Cash. NB: The first part records the transformation of the product, the second part records the work being done on the transformation. Then, you sell the finished goods: DR – Cash, CR – Finished Goods; and you recognize the costs of what is sold: DR – Cost of Goods Sold (COGS), CR – WIP.

That is a lot of accounting jargon but I haven’t figured out a better way of illustrating this stuff in a blog format yet.

Now imagine creating fiat vouchers. They are printed on paper, but once complete they represent the unit of measure and not an item of inventory. When your widget inventory is $1,000, it means you have one-thousand dollars worth of widgets. You can’t have an inventory of one-thousand dollars worth of dollars–not in any sensible way.

Lets imagine this process was still with a gold coin. First you “buy” the raw gold (pay laborers to mine it): DR – RMI, CR – Gold Treasury. Second, you process the raw gold: Step 1 – DR – Gold treasury, CR – RMI; Step 2 – DR – COGS, CR – Gold Treasury. (NB: I’m simplifying Step 2 because you’re paying the minter to mint Gold coins, that is what is represented by COGS). This works because the Gold treasury is an inventory of actual Gold coins.

When you have a Gold-backed currency, it stays simple. The Gold treasury becomes one step removed, and instead you issue vouchers that are called “Gold Payable”. Issuing Gold-backed currency looks like this: DR – Some Expense, CR – Gold Payable.

So at our simplest form, we are dealing with a Gold Treasury as the inventory of the asset, Gold as the raw material being processed, and Gold Payable as the issuance of Gold-backed currency.

Fiat vouchers removes Gold from the equation. There is no Gold treasury because there is no asset aside from mere paper, but now even paper isn’t necessary. There is no asset so there is no material to process. So we are cutting out the WIP and COGS part of it and we are left with merely DR – Some expense, CR – Fiat Vouchers Payable.

The reason this doesn’t work is because Zippy’s point of view is that all liabilities represent claims on some asset. CR – Fiat Vouchers Payable is a liability, but there’s no underlying asset to claim against.

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This is interesting to me because it feels as if the ideal currency is one which costs nothing to make, which was difficult before but is easy now. It literally represents free money. It makes sense why this would be the ideal and why society–or government–would move towards it. I wonder if the United States even goes through the formality of printing bills before sending money to banks, or if there’s not a computer algorithm somewhere that just adds zeros.

There is a way I could fudge the accounting without breaking accounting rules that would provide an asset that the fiat vouchers could claim against: Goodwill. When a company buys another company for more than their book value, the difference in valuation is referred to as goodwill, and will be amortized over some period of time since it doesn’t represent anything real. This does actually happen, even if it sounds nonsensical. Companies will pay a premium for a brand, or for access to a market, or access to a product. One could argue that the difference between real assets on the books and fiat vouchers payable is goodwill for the government. The government can retire fiat vouchers payable, and reduce it’s goodwill such that it’s assets approaches only its real value. Or the government can issue more fiat vouchers payable and increase its “goodwill”.

But again–it’s not really increasing goodwill in this case. And the operating arm of the government still needs to operate in dollar-denominated slips of paper.

Let’s see if we can simplify further by going back to the Sovereign and the Gold Treasury. If we look at the Sovereign as the owner of the state–not just the ruler, but he holds the title, the deed, for the state and the people and markets within it, then all money is a distribution from his personal reserve. So even with Gold, all money is “due” back to the sovereign anyway–it’s his, and he’s given it to you as a medium of exchange. This is all very simple with a unitary sovereign, but if we accept that the Liberal ideal is that the people is sovereign, collectively, then it becomes very muddled. Whose money is it?

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Here’s another thought I had. Is it true that the ideal currency is one that is spontaneously created out of nothing? It wasn’t possible until the digital age, but now it is. It has no intrinsic value so serves exclusively the role of medium of exchange. A collection of currency represents your exchange power, and as long as everyone else accepts that medium, you can exchange the increments of nothing for hard assets.

In a sense, if you earn an income you are collecting “deferred assets” by collecting an income, and when you trade those “deferred assets” in for hard assets you move them around on your balance sheet. Taxes would then represent giving the Government as an organization some deferred assets.

Furthermore–if the ideal currency is spontaneously generated ex nihilo there would need to be some kind of meta entity responsible for generating and retiring currency, because an ex nihilo currency would need a single-sided accounting entry to just increase or decrease its supply. From the meta entity, accounting would proceed as normal but it takes the problem of currency out of the USG balance sheet and moves it to the meta-entity.

I’m going to need to take these ideas and clean them up a bit but I hope you can follow my train of thought.

AMDG

CCXLVII – Consistency vs. Accuracy

I have mentioned before that I am an accountant. There’s a phenomenon I have observed wherein accountants want things to look the same, or they want things to look right.

Neither approach is technically wrong, to be clear. It’s just an interesting character trait–how an accountant falls on this dichotomy tells you something about their attitudes as people, and that is what justifies my making this observation on this blog.

The typical relationship accountants have with an organization is something akin to an advisor to a king. We aren’t on the throne, but we are close to it and can see if the king is being listened to. The king might ask us for advice and we will turn to our stacks of ten-column paper to speak the truth to him. We simultaneously monitor the health of the organization and advise as to its management.

Consistency Accounting follows the principle that the performance we see this month should closely resemble the performance we saw last month. The virtues of this include that an accountant will know if anything unusual happens because it will stick out on various reports, and be easily identified as unusual. If you are not familiar with accounting, a term that we live by is “Accrual Accounting” which means that if I pay a bill for a whole years worth of some service–say $12,000 paid in January–I can spread the recognition of that expense out over the whole year. So instead of seeing a $12,000 expense in January, I will see a $1,000 expense in the same place every month for 12 months. Accrual accounting is what makes this possible. Consistency accounting relies on accruals, such that future months can be forecast because much of the activity is being accrued. As such, consistency accounting is something of a procrustean bed whereby transactions are forced to fit into the noise level of normal month-over-month variation.

Accuracy accounting follows the principle that the performance we see this month should reflect events that actually happened. Accuracy accounting still uses accruals, but when something sticks out the question is less “should we have spread this out” and more “did this actually happen”. Sometimes $12,000 expenses happen in a sufficiently large organization without warning. It’s not a failure to recognize it all at once and say “we need warning about this next time”.

I am not a fan of consistency accounting because it loses sight of what is happening and focuses on what we want to happen. It’s the natural result of performance evaluation’s being based on financial results. Middle managers have an incentive to hack the books to save their bonus rather than focus on saving the company.

Not really a point to this, just an observation.

AMDG