Where do profits come from?

[Joe Leote]

Coherent discussion of Monetary Circuit Theory with proposed modifications:

Where does the money for company profits come from?

Joe

[Joe Leote]

Even with no external Government sector the short-term profit in the Firm sector comes from banks issuing new debt directly to Households. Profits are sustained in the short-term, during the boom stage of the aggregate economy, by the growth of so-called Consumer Loans. When old loans are repaid with cash flows tied to the growth rate of new loans there are short-term profits in the firm sector even without a government sector. The owners and managers of the firm sector (producers) accumulate claims to equity, debt, and real goods while the ultimate debtors owe those claims to the households with net claims on the debtor households through the financial firms and other firms which are intermediaries between household debtors and household creditors. In the long run disruption of consumer loan growth will cause systemic debt default because firms layoff household workers to repay firm debt in a cash flow crisis. This means some workers will default on consumer debt when firms use pricing power to repay their debts. Governments don't usually bailout consumers directly although bankruptcy laws provide some relief from the claims of creditors. Governments bailout the crucial or key firms in the finance and production sector to prevent systemic unemployment, debt default, and outcomes similar to The Great Depression.

Joe

[Joe Leote]

To my knowledge economists have discussed and debated the source of profits for many centuries. In a closed private economy, with no external sector and no public goods provided by governments, firms make profits when the total cost of goods sold is in excess of the total costs of production. The aggregate wage bill, the total wages paid to labor from working class households, must be below the total costs of goods sold, plus other non-wage costs, to ensure the firms make profit in the aggregate economy. If wages are always below the costs of goods sold whenever there are aggregate profits, and because workers tend to save out of wages, then logically there ought to be a persistent production surplus which does not clear markets at a profit (due to insufficient wages and monetary saving by working class households). Direct loans to firms don't explain profits. However, direct consumer loans to working class households, extended by the bank sector or the internal firm finance departments, enable debtor households to purchase the production surplus which explains the firm profits. Creditor households accumulate claims on the debtor households using banks, firms, and other legal/accounting institutions as intermediaries between wealth and working class debtor households. Modern financial customs use consumer and investment loans to trade "secondary" or pre-existing assets (asset inventory) which were produced, not in the current Monetary Production Circuit, but which were produced as output by a prior MPC. Loans for the purchase and sale of asset inventory tend to bid up the price of assets fueling asset price inflation or asset price bubbles. Conditions in the credit system are a feedback into the credit decisions via macroeconomic sentiment. When credit issuing dealers expect other credit issuing dealers to restrict credit terms this can trigger a collapse in asset values, or firms to layoff workers to control costs and ensure profits and repayment of debt, and the combination of falling asset values and increasing unemployment causes increasing debt default rates and more restrictive credit terms. Profits in firms are tied to the credit system in boom bust cycles. The modern financial economy is more complex than the old economic models for the business cycle.

Joe