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Applying double-entry bookkeeping

24 October 2017

Introduction

Four of my earlier articles, written in 2012, were inspired by what I read on the site bibocurrency.org, written by Marc Gauvin and others. Today, he is one of the people behind the newer site Money Systems Transparency Alliance.

As I wrote earlier, I don’t agree with them at all. I think the authors see problems where they aren’t any, as a result of an incorrect application of mathematics and formal logic to the practical realities of daily life.

Today, I’ll be looking at some actual quotes from the new site and the old.

Core misrepresentation

A quote from The Misrepresentation of Money – Core misrepresentation:

«Colloquially, we say “so many dollars worth” of this or that, implying money is a measure of value. However, we also say “I’ll give you ten dollars for that….” which implies money is also a tradable commodity, but is this logically sound?

While a bag of flour in my kitchen has a certain weight, that measure cannot represent the weight of flour in your kitchen. If both of us have a kilo of flour,  then although equal in magnitude, each measure is distinct in that they refer to different instances of flour.  Measures are always “of”  other things never of themselves.   That is, while it makes sense to say a ‘kilo of flour’, it doesn’t make sense to say a ‘kilo of kilos’.   Similarly, it makes no sense to say a ‘dollar’s worth of dollars’.
»

I say: there’s a simple solution to this:

In the phrase “I’ll give you ten dollars for that…”, the word “dollars” is actually short for ‘coins or banknotes with a value of ten dollar’, or ‘part of my claim on the bank (i.e. the balance in my bank account) worth 10 dollars’.

So the value of products as well as money (money is what banks owe the public) can be measured in terms of dollars.

The point is that ‘dollars’ in such uses has a different meaning each time. Marc Gauvin confuses those meanings, and that causes his wrong conclusion, which is that something is impossible although people do it every day. That cannot be right. And it isn’t, because as in the interest issue, Mr. Gauvin applies the mathematics in a wrong way.

Adding it all up

Another quote, now from Money: Commodity or Measure – Not Both:

If money is generated by transactions as a record (annotation) OF the value of goods/services being transacted as described by the Bank of England here and here then that record cannot be assigned INDEPENDENT value in and of itself.


Definitions:
   Let A ≥ 0 (annotated value of goods/services transacted)
   Let B ≥ 0 (independent value attributed to the annotation of value i.e. "money")
   Let C = A+B (Total value of any annotation)
 
Proof
   If A > 0 and B > 0, then A+B ≠ A and C ≠ A.
   If B = A then A+B = A if and only if A = 0 and B = 0.
   Therefore for any A, C = A if and only if B = 0 !
End of Proof.

Where this goes wrong is here:

Let C = A+B (Total value of any annotation)

The point is that the goods and the money paid for them, are exchanged. Before, during and after such exchange, the goods and the money do not have the same owner! That is why addition makes no sense here.

Therefore the rest of Mr. Gauvin’s reasoning is also invalid, although it looks convincing with all the mathematical symbols.

The solution is to not simply do additions and subtractions, but instead to use double-sided bookkeeping, in Luca Pacioli style. That method does properly keep track of what to add and what to subtract, by using debit and credit and by distinguishing owners: each party in a transaction has its own books and its own balance sheet. It isn’t right to add items for one balance sheet to items in another, and debit items must not be added to credit items.

Money circulation

Quotes are now from Money does not circulate, published 19 August 2013.

Since we annotate transactions in pairs a positive against a negative i.e. when A buys real goods and services from B, A annotates -1 and B annotates +1, it gives us the false impression that A's "stock" increases B's. However, if we consider the very first transaction of such a system where logically A and B each have zero balance, it becomes clear that there is no such transfer of a finite "stock" since none previously exists!!!

Here too, double-entry accounting solves the problem.

Trading goods

For A to be able to buy goods from B, initially B must own the goods, and A must own money. So their simplified balance sheets, just showing these items and equity, and assuming the price is 1000 dollars, are as follows:

Balance sheet of A:

Description Debit (assets) Credit (liabilities)
Money in bank account 1 000
Equity 1 000

Balance sheet of B:

Description Debit (assets) Credit (liabilities)
Goods 1 000
Equity 1 000

The sales transaction involves the following changes:

Debit (assets) Credit (liabilities)
A:
− Money in bank account
+ Goods
B:
+ Money in bank account
− Goods

After the transaction, the situation is reversed in comparison with the initial situation, because the goods and the money have been exchanged between A and B:

Balance sheet of A:

Description Debit (assets) Credit (liabilities)
Goods 1 000
Equity 1 000

Balance sheet of B:

Description Debit (assets) Credit (liabilities)
Money in bank account 1 000
Equity 1 000

This way, all the positive and negatives are assigned to the correct columns of the balance sheets, and to the correct parties involved in the transaction.

Trading services

If the transaction is about services instead of goods, buyer A must initially have money, but B could in theory start with all zeroes (although of course in reality, some initial investments must have been done to set up the business):

Balance sheet of A:

Description Debit (assets) Credit (liabilities)
Money in bank account 1 000
Costs of buying services 0
Equity 1 000

Balance sheet of B:

Description Debit (assets) Credit (liabilities)
Money in bank account 0
Proceeds of rendering services 0
Equity 0

Invoicing by B for rendering of services to A, and payment by A to B, causes the following changes:

Debit (assets) Credit (liabilities)
A:
− Money in bank account
+ Costs of buying services
B:
+ Money in bank account
Proceeds of rendering services +

After the transaction, the situation is:

Balance sheet of A (including profit and loss):

Description Debit (assets) Credit (liabilities)
Money in bank account 0
Costs of buying services 1 000
Equity 1 000

Balance sheet of B (including profit and loss):

Description Debit (assets) Credit (liabilities)
Money in bank account 1 000
Proceeds of rendering services 1 000
Equity 0

We see that for A, the incurred costs by the end of the business year will decrease Equity (reducing it to zero, in this unrealistically simplified example), whereas for B, due to his proceeds from rendering services, equity will rise from zero to one thousand. B will have made a profit.

Circulation

Quoting the next paragraph from Money does not circulate:

Hence money is not a circulating thing but rather it is an annotation of the value of the real goods and services which are the only things that "circulate". Those goods and services in turn represent the hours and effort of real people with real aspirations and needs and that have given of themselves.

The circulation of money means that amounts go from one bank account to another, as we see in the examples above. Parts of claims of the public on banks, are transferred to other members of the public. If payments are made in cash instead of bank accounts, using banknotes, what happens is essentially the same, except that the claim is on the central bank (who issued the banknotes) instead of on a commercial bank.


Copyright © 2017 R. Harmsen. All rights reserved.

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