Monday, September 29, 2008

Peak Profit Growth

Businesses measure their success by comparing their profits from one interval of time to another. Profit – roughly speaking, the difference between income and expenses – is generally used for several purposes: to enable future growth; to help the organization survive future decreases in revenue (anticipated or not); and (for corporations) to reward those people who helped pay for past growth (investors).

For a business to be considered successful, its profits must always be increasing. An investor who pays 100 dollars expects to be paid a certain percentage of that amount out of profits (“interest”) after a year; if the original amount plus interest is reinvested, then the same (or higher) percentage of the new amount is expected by the end of the following year. The business must also make enough extra profit to continue growing if some of its investors withdraw all of their investments. As a result, businesses try to grow exponentially.

The economic success of a country and the world is also measured in terms of growth, where “profit” is equivalent to the increase in Gross Domestic Product (GDP) from one year to the next. Economic activity and consumption of resources are closely tied together; so that as businesses or economies grow, consumption grows proportionally. Equivalently, the dynamics of consumption translate into equivalent patterns of money flow.

My combined population model (and the laws of consumption it embodies) predicts that world per capita consumption will stop accelerating this year and its growth rate will begin decreasing. If profit growth follows suit, which it should, then investment will decline; credit, which is a bank’s version of investment, will also drop. When per capita consumption (and overall consumption) stops growing entirely, the world population will reach its maximum size; after that, resource depletion will reduce consumption, more people will die than are being born, and the population will crash.

It is hard to ignore the similarities between my model’s prediction and those of the current economic crisis. Interpreted through the lens of my model, it appears as though speculators (whose job it is to anticipate future economic growth) expected growth to continue, assigning corresponding value to investments that turned out to be imaginary and ended up overvaluing those investments.

1 comment:

Bradley Jarvis said...

The proximate causes of the "mortgage meltdown" are three symptoms that would be expected in a condition of peak per-capita consumption growth: (1) unexpectedly dropping value of property relative to expectations, due to (2) a decrease in demand growth forced by income that isn't growing fast enough to keep up with expenses, and accompanied by (3) an increase in interest rates so that lenders can recover their investment, which is unrecoverable -- and unpayable -- by the owner because of lower future income and lower future value of the property. This forces the owner to abandon the property and drive up supply relative to demand, which further decreases the value of other people's properties.