Forbidden Economics: What You Should Have Been Told but Weren’T

By William C. Orthwein

As soon as you enter the work force, you must earn, spend, save, and invest wisely the money you receiveor suffer the consequences if you dont.
Making the right decisions will be easier once you understand how the economy really works. For instance, did you know that all material wealth comes from just three activities: farming, manufacturing, and harvesting whatever was not planted?
Get the wisdom you need to save and keep more money andif youre a government worker, politician or a concerned citizen seeking to influence elected leaderstake steps to improve the national economy. Youll also discover how to:
protect wealth from money lenders, governments, and others who want to take it.
apply an understanding of supply-demand curves, forms of money, and basic economic concepts to improve your economic status.
promote the preservation of valuable natural resources.
By examining economics at the personal and national levels, youll be better equipped to take control of your own future. Whether its getting a car loan, deciding what mortgage is right for you or understanding the inner workings of the Federal Reserve, youll be empowered by the insights in Forbidden Economics.

• Language: English
• Publisher: Archway Publishing
• Release date: Nov 4, 2014
• ISBN: 9781480810006

William C. Orthwein

William C. Orthwein earned a bachelor’s degree in physics from MIT, and a master’s degree in mathematics and a doctorate in engineering from the University of Michigan. Before retirement he worked in the aerospace and defense industries, and in academia. After retirement he became interested in the mathematics underlying everyday economics and the insight gained from the implementation of that mathematics motivated this book.

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Copyright © 2014 William C. Orthwein.

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ISBN: 978-1-4808-0999-4 (sc)

ISBN: 978-1-4808-1001-3 (hc)

ISBN: 978-1-4808-1000-6 (e)

Library of Congress Control Number: 2014915372

Archway Publishing rev. date: 10/30/2014

CONTENTS

Preface

Introduction

Chapter 1 — Personal Economics

Chapter 2—National Economics

Chapter 3—Wealth

Chapter 4—Money

Chapter 5—Banking

Chapter 6—Inflation and Deflation

Chapter 7—Depressions

Appendix

Chapter 8—Government

Appendix 1

Appendix 2

Chapter 9—War

Epilogue

Bibliography

List of Graphs

List of Illustrations

PREFACE

This book was written by a retired engineer to present the fundamentals of economics as they apply to everyday living. These fundamentals can be divided into two groups: those for personal economics that guide personal decisions, and those for national economics that are presented for use as a guide for voting and background information. The latter is used for contacts with elected officials because national economic policies can seriously affect everyone’s personal economics and financial security.

For personal economics the four fundamentals are as follows:

First, spending should never exceed 85–90% of income. The remaining 10–15% is to be saved or invested to have money for unforeseen future emergencies.

Second, borrowing should be held to a minimum. Spending that includes loan payments should be within the above limits.

Third, carefully and thoroughly read all loan and mortgage documents, including the total amount (plus all fees and charges) required repay the loan or mortgage. Do not be rushed when reading all loan documents. Demand an explanation of unfamiliar words and statements. Money lenders can be cunningly deceptive. If rushed—leave.

Fourth, guard against currency inflation by saving very little fiat currency (paper currency; see chapter 5 for more information). Most savings should be in the form of interest-paying securities or material items (e.g., real estate, affordable industrial tools and equipment, or gold and other precious materials that have industrial uses).

The five most important fundamentals for national economics are as follows.

First, all material wealth is produced by farmers, manufacturers, and miners. Therefore they must be allowed to prosper. These wealth producers then exchange wealth among themselves and exchange wealth for service from their service providers and government.

That encompasses all the gainfully employed of both genders in any society. Without wealth producers there is no material wealth. Stay-at-home mothers are included in this group because they are building the foundation of future wealth producers. That is one of the two most important human activities. The other is either producing wealth or providing services to the wealth producers.

Second, advanced technology is the foundation of all prosperous nations and is essential for a high standard of living in any nation. Technology is the hallmark of Germany, Japan, and Switzerland, and to some extent Brazil, Czechoslovakia, England, and France. It is the nourishment for a higher standard of living in China and India, and it supported prosperity in the United States before a foolish government encouraged the outsourcing of manufacturing and the technology that accompanies it.

Third, without mothers, all wealth production would stop. No more people.

Therefore, mothers and wealth producers and their service providers must all be encouraged, protected, well educated, and perpetuated if a nation and its people are to be prosperous and happy.

Forth, small government is a blessing and large government is disastrous.

Fifth and last, all societies are divided into three groups: wealth makers, service providers, and wealth takers.

Wealth takers, as do wealth makers, fall into three groups: thieves, welfare recipients, and large governments. Of these the thieves and welfare recipients return nothing of value for the money taken from the wealth producers.

Small local governments that efficiently provide the necessary legislative, judicial, and police services, as well as small national governments that efficiently provide those services listed in the United States Constitution, may be classed as valuable service providers that are willingly paid by the wealth producers.

In contrast, officials in a large government with excess personnel, un-necessary agencies, and overarching authority become wealth takers. They engage in legalized theft from the wealth makers in a democracy in order to buy votes from their welfare recipients and thereby enhance their own wealth in attempting to solidify their hold over government and the wealth makers. These avaricious officials differ from ordinary thieves only in that they have the police power of government to enforce their interaction with the wealth makers.

Because this book is concerned only with these fundamentals, it will concentrate on what are perceived to be those aspects of economics that directly affect most of the working population in any society. They are the aspects that must be understood by everyone who would prosper in any free economy.

INTRODUCTION

This book differs from standard books about economics in that it is concerned only with those aspects of economics that directly affect almost everyone who is gainfully employed.

As noted in the preface, the purpose of this book is to present the fundamentals of both personal and national economics. With this information, the reader may decide which path to take, and which elected officials and legislation to support to obtain personal financial security and happiness. This information can also serve as a guide for which government policies an alert and well-informed citizenry should insist be adopted and implemented to ensure national economic security and prosperity for all individuals.

Laying bare the fundamentals of personal and national economics regardless of whether they are or are not politically correct is necessary for a practical and workable understanding of economics.

The central ideas in each chapter are given on the first page or two of each chapter.

Since personal economics is about money, it is important to do the arithmetic (addition, subtraction, multiplication, and division of real positive numbers) involved in keeping spending and savings within income guidelines and in calculating the cost of any loans. In some examples the required arithmetic is displayed and shown to be simple. That arithmetic should be performed before a loan is accepted. Mathematics (more than just arithmetic) involving logarithms and series summations is used to calculate the monthly payments in several loan examples and in other calculations in economics. (Both the simple and the more involved formulas may be obtained by e-mailing [e-mail].) However, the results from these calculations are displayed graphically so it is not necessary to understand the math to comprehend and use the economic principles involved.

The first chapter deals with basic definitions that pertain to personal economics and to several of the more common types of loans, as well as the important details of such loans. Loans (and mortgages—loans secured by real estate) are considered in some detail because almost everyone regardless of income must at one time or another borrow money even though borrowing is expensive and should be avoided whenever possible.

The remaining eight chapters deal with the various aspects of national economics that establish the milieu in which everyone must attempt to earn a living. History of world governments shows that governments usually tend to grow with time and exert more and more control over their citizens. These eight chapters describe those government actions that can affect each individual’s economic welfare so alert citizens can be aware of the consequences to themselves of uncontrolled government legislation and act accordingly.

Each chapter attempts to display the underlying principles for the topics covered, as well as the related traps set for the unwary by private organizations and the deceptive tricks employed by governments.

The notion of a wealth dump, as introduced in chapter 3, is to emphasize the transient nature of wealth as it flows from the wealth makers to the wealth takers in government and then directly to the dump. Any wealth stored as paper currency is slowly drained to the dump by inflation, and wealth stored in the form of precious materials goes to the dump when it is eventually exchanged for items that either provide enjoyment or that require maintenance and services.

Farming, manufacturing, and mining are the wealth makers and are the cornerstones of national wealth. This is discussed at the opening of chapter 3 and highlighted again in subsequent chapters.

Economics has many arcane, controversial, and anfractuous aspects. They are not considered here. Only the more obvious, fundamental, and readily applicable aspects of economics will be considered in this book because they are the ones that directly affect all individuals.

Note to grammarians: Throughout the following text percentages will be written as 5%, 10%, and so on, instead of as five percent or either as ten percent or 10 percent. This is for simplicity and clarity, as displayed in financial and merchandiser ads in which the advertisers heed the advice of advertising agencies that have meticulously studied consumer response to a variety of ad contents and write Save 5% instead of Save five percent in sales advertisements.

CHAPTER 1 — PERSONAL ECONOMICS

Synopsis: Personal economics consists of awareness of four fundamental rules of personal economics: acquire a skill, save money, borrow only when absolutely necessary, and read and thoroughly understand any and all signed agreements. Different ways of calculating interest on loans and on savings plans, the expense of borrowing money, and the associated wisdom of saving money are described by examples of each and should be understood.

Fundamentals

There are four fundamental principles for personal economic security, which are as follows:

First, and most important, acquire a necessary skill, either through personal study and ingenuity or through a formal education, and become proficient in it in order to have a durable income.

Second, borrow money only when it is absolutely necessary, and then borrow the minimum amount necessary (e.g., for your first home, first automobile, etc.). Save as much as possible for future emergencies. Do this to avoid the interest expense of borrowing money. It can be significant.

Third, sign no loan agreements or contracts that you have not read or do not completely understand. Take time to read them carefully. Do not be rushed. Ask questions until you do understand. If the answers are not understandable or not satisfactory, do not sign. Go elsewhere.

Fourth, be honest even when dishonesty may seem easier. It establishes your reputation.

Details

Borrowing and Saving

Money lenders want to get paid. Their payment is called interest, and it can be excessive. Explanations regarding the type of interest, how it is to be paid, and the penalties for late payment may be intentionally confusingly worded. Because of this, borrowing money can be extremely expensive to those who do not read and fully understand the agreements they have signed.

The remainder of this chapter gives details about some of the different ways of calculating interest in loans and in savings. In a sense, borrowing money is an analytical contest between lender and borrower.

The amount of money lent to a borrower is known as the principal. The life, or term of a loan, is the length of time the loan will be in effect. The cost of a loan is the difference between the total amounts of money to be paid to the lender minus the amount of money received from the lender. It is the sum of all fees and charges plus the total interest paid over the term of the loan. Next, interest is the percentage of the loan amount that is charged by the lender for making the loan. Finally, a loan on real estate is known as a mortgage, and a loan on other property is known as a chattel mortgage.

There are two kinds of interest: simple and compound. In the remainder of this chapter, whenever the word interest is used without modifiers, it will denote simple interest. (Simple interest is also known as nominal interest.) Simple interest is the simplest to calculate and the easiest to understand. It is the percentage of the principal the lender charges for the loan on a yearly basis. Although it is quoted on a yearly basis, it can be apportioned on a daily, weekly, or monthly basis. Loans having terms less than one year are usually written with the loan’s life expressed in days or months. Longer terms may be expressed in years, months, days, or any combination thereof.

Compound interest begins as modified simple interest that is calculated for shorter periods of time and then added to the principal at the end of that time period. The sum of the two then becomes the principal for the next interest calculation. Time periods may be a month, a week, a day, or zero. (A special formula is used for periods of zero time. It is the limit of the other formulas as the time period goes to zero, and the result is called continuous compounding.)

In practice, banks and financial organizations are free to compound interest on loans and savings accounts for whatever time periods they want. Thus, some will compound interest each month, others each week, others each day, and still others will compound interest continuously. In all cases they charge different interest rates on loans than on savings accounts, and they may compound the interest differently on loans than they do on savings accounts. Finally, most, if not all, may charge different rates and use different compounding intervals for small loans, large loans, short-term, and long-term loans.

The rationale for these differences is evident from figure 1-1, which shows the interest received by the lender for each $100 of a loan as a function of the term of the loan. The interest rate on the upper pair is 5% and the interest rate for the lower pair is 2%.

The lower straight lines in both pairs show the amount accumulated when simple interest is used, and the upper curves show the amount accumulated when the interest is continuously compounded. Differences between monthly, weekly, daily, and continuously compounded interest are too small to show on the scale of the graph. The accumulated interest for all longer compounding intervals for these two interest rates falls between the upper and lower curves for each pair.

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Figure 1-1. Accumulated interest for either a $100 deposit or loan at 2% (lower pair) and at 5% (upper pair) interest rates. Simple interest is depicted by the lower straight line in each pair and continuously compound interest is depicted by the upper curve in each pair for terms up to 12 years, or 144 months.

To be specific, after 12 years, or 144 months, simple interest at 5% on $100 amounts to $60.00, monthly compounded interest amounts to $81.98, weekly compounded amounts to $82.15, daily amounts to $82.20, and continuously amounts to $82.21. Thus, the spread is 23¢ after 12 years for these last four compounding methods and would, of course, be less for interest rates smaller than 5%. There is also very little difference between weekly, daily, and continuously compounding even after 30 years. Interest on $100 at 5% after 30 years that is compounded weekly is $447.79; if compounded daily it is $448.12, and if compounded continuously it is $448.17. The largest difference is 38¢/$100.

Since the graph is for a $100 deposit or a $100 loan, the vertical scale in figure 1-1 may also be interpreted as the percentage gain (i.e., the accumulated simple interest gain is 60% of the initial amount after 12 years at 5% per year). Likewise, the accumulated continuously compound interest gain is 82.21%, or 22.21% greater.

Barely distinguishable differences between compound interest and simple interest for no more than 60 months at 2% is why banks limit certificates of deposit to five years or fewer when they advertise weekly, daily, on continuously compounded interest at this rate or less. Compound interest promises a greater return, but that promise is deceptive because the return is only slightly greater than that from simple interest. Similarly, compounding may be limited to two years for a 5% interest rate.

Figure 1-1 also explains why banks usually offer only simple interest rates on savings accounts in which large amounts and longer terms may be involved.

There are as many ways of calculating and collecting both the interest and the principal as devious lenders can devise and as the laws will allow. And their deviousness increases as loan modifications made to compensate for inflation adds more variety to interest rates and charges, as will be further discussed in chapter 6.

Three of the more common methods used for calculating interest on loans when inflation is negligible will be considered in detail here. They are

simple interest charged over the life of the loan,

compound interest charged over the life of the loan, and

interest charged on the unpaid principal between periodic payments and included in the next loan payment. (This is known as a self-amortizing loan.)

Whenever lenders advertise interest rates without specifying whether the rate is simple or compounded, it is usually compounded either weekly, daily, or continuously. Noticeable inflation can significantly alter these types of loans, as will be discussed in chapter 6.

Simple Interest Calculated over the Life of the Loan

As stated earlier, simple interest is the easiest to calculate because it is simply the product of the amount of the loan times the interest rate per year times the number of years or fractions thereof.

Example

A borrower takes out a loan for $20,000 at 5% simple interest for four and one half years.

According to the terms of the loan, the borrower must pay

$20,000 × 0.05 × 4.5 = $4,500

in interest to pay off the loan. Thus the lender will receive

$20,000 + $4,500 = $24,500

after four and one half 4.5 years. The cost of the loan is $4,500.

Often lenders require monthly payments during the life of the loan in order to be sure of recovering at least part of their loans and to get a greater return by reinvesting each payment. If the above loan were to be paid in 54 payments, the monthly payment would be

$24,500/54 = $453.70.

However, there is usually a slight complication, as in this case, because of the round-off error when the payment amount is rounded to the nearest penny. Here $453.70 × 54 = $24,499.80, or 20¢ too little. Thus the first payment will be $453.90 and the 53 remaining payments will be $453.70.

To receive a greater return, the lender may reinvest each monthly payment in an interest-bearing investment. If each of the above payments were placed in a savings account that paid 1.5% simple interest, the lender would receive $25,341.98 after 54 months, which is an extra $841.98 over what would have been received had the borrower made one interest payment at the end of 54 months.

Compound Interest Calculated Daily over the Life of the Loan

Compound interest that is compounded daily during the life, or term, of a loan is calculated from the formula

Principal × (1 + interest/365.25) × (number of days in the term of the loan)

The interest in percent is divided by 365.25, which is the actual number of days in each year, because interest is usually quoted on a yearly basis, although it may be compounded on a weekly or daily basis, as it is in the above formula, or continuously. For daily compounding, the interest accumulated each day is then added on to the principal at the beginning of the next day, and then the interest on that sum is calculated and added on to get the principal for the next day and so on for the life, or term, of a loan.

This compounding of the interest on the principal of a loan for the term of the loan is the most expensive of the four schemes for the borrower when there is no inflation. It is therefore most profitable for the lender.

A common trick lenders use to extract more money from those who borrow money without examining the cost of a loan is to advertise longer-term loans with lower monthly payments as a means of the borrower saving money each month due to the smaller monthly payments. Such so-called monthly savings are an illusion because compounding the interest over the longer life of the loan increases the lender’s profit by disproportionably increasing the number of payments made to the lender. Thus the increased loan costs drain more money from the borrower than would have been drained with larger payments over a shorter length of time (i.e., a shorter term).

The decrease in monthly payments obtained by increasing the life of a loan in which the interest for the entire loan is compounded continuously over the life of the loan for each $100 of the loan is shown in figure 1-2. Again because the graph is for $100, the payments it also corresponds to the percent for a loan of any amount that must be paid for a similar interest rate and term. Thus, payments at 3% continuously compounded interest for a twenty year, or 240 month, $100 loan as read from figure 1-2 would be 75¢, or 0.75%. Thus the corresponding monthly payments on a $100,000 loan would be $750. Its actual amount is $759.22, except for the first payment of $758.30 to account for round-off error.

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Figure 1-2. Monthly payments for each $100 of a loan as a function of the term of the loan from 24 months to 360 months for interest rates of 3, 4, and 5%, with 3% described by the lower curve and 5% described by the upper curve. Interest is compounded continuously through the term of the loan for the most expensive type of loan.

It is important to notice that loan payments continue to decrease with time through 360 months for a 3% loan, that they almost level off with time between 288 and 360 months for a 4% loan, and that they reach a minimum at 240 months for a 5% loan and then begin to increase for longer terms. Thus, it is evident that monthly payments reach a minimum sooner for higher interest rates and then increase more rapidly with time as the interest rates increase. Consequently, lenders offer longer terms with lower interest rates in order to induce borrowers to take out such loans at lower monthly payments, but lower rates will make it more expensive in the long run to pay off the loan.

Payments fall rapidly for terms fewer than 72 months for the interest rates shown simply because dividing a loan into more payments makes each payment less and because continuous compounding of the interest has only begun to grow the principal by adding increasingly significant amounts to the debt, even for interest rates as low as 3%. Higher interest rates naturally add proportionately more to the debt as the loan terms increase, as indicated by the 4% and 5% curves that show the extent that payments begin to increase after 240 months for interest rates of 5% and higher.

The penalty for accepting longer terms in return for lower monthly payments is that the total costs for such loans rise spectacularly as their terms increase. That is shown in figure 1-3. The upper two curves for 100 units of currency, such as $100, especially show that when the interest for the loan is compounded over the life of the loan, the interest burden becomes excessive and overwhelming whenever the life of the loan exceeds 10 years or 120 months.

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Figure 1-3. Total amount paid to discharge a loan for each $100 borrowed at nominal interest rates of 3, 4, and 5%, in that order from the bottom curve upward for interest compounded either daily or continuously for from 2 to 30 years.

Lenders who make such loans for even eight years (96 months) or more are known as loan sharks because they devour the income of their unfortunate borrowers, as will be demonstrated in the following example which shows the dollar expense associated with the middle curve in figure 1-3.

Example

A borrower takes a loan of $100,000 at 4% for 20 years, or 240 months, from a loan shark. The monthly payments are $926.08, with the last payment reduced to $925.09 to compensate for round-off errors. The interest is to be compounded daily.

To compare these monthly payments with the curves in figure 1-2, enter figure 1-2 at 240 on the abscissa, the horizontal axis, and read up to the middle curve and then over to the ordinate, the vertical axis, to get about 0.90. Multiply that by 1000 to get approximately $900 per month, for an error of 0.66% from the actual amount after round-off to two places. Close enough to continue.

Next consider the cost this loan using figure 1-3 in a similar manner.

The cost of this loan may be estimated from figure 1-3 by entering at 240, reading up the 4% curve, the middle curve, and reading over to the ordinate to read about 225. Again multiply by 1000 to get the total amount paid to redeem the loan to be about $225,000.¹ The exact amount is $223,495.63. In other words, the borrower will have paid the lender $123,495.63 after 20 years for an original loan of $100,000. Thus the cost of the loan is greater than the value of the loan itself. That is the bite of the loan shark.

Use of curves for continuously compounded interest to estimate the monthly payments and the total cost of a loan in which the interest was compounded daily is justified by the negligible difference between continuous, daily, weekly, and monthly compounding for terms of 30 years or fewer, as noted earlier. The small errors displayed here confirm that.

Guided by figures 1-1, 1-2, and 1-3, it is evident that weekly, daily, or continuous compounding for large loans, such as mortgages, with terms greater than five years and for interest rates above 3% should be avoided whenever possible. They are the most expensive type of loan; they give the lender, or mortgagee in the case of a home mortgage, the greatest profit.

Annual Percentage Rate (APR) and Annual Percentage Yield (APY)

The Annual Percentage Rate, or APR, for a loan is the simple interest that would have to be charged by a lender to give the same financial return as would be received by the lender after one year from whatever method is actually used to calculate the interest due. It is also informative to introduce an Equivalent Percentage Rate, or EPR, which is the simple interest that would have to be charged for more than one year. It is a generalization of the APR.

To calculate it when other fees are included, add all the payments and any other fees and charges associated with the loan and then subtract the original amount of the loan. Next divide that total amount by the number of years and fractions thereof in the term of the loan, and then divide that result by the amount of the principal. Lastly, multiply the result by 100 to change it to a percentage.

Lending institutions usually do not include fees in calculating their APRs. That is part of the deception.

APRs are important because differences in the costs among loans with different compounding methods may be detected by different APRs whenever lenders are required to announce the APRs of their loans. Similarly the Annual Percentage Yield, or APY, is a correspondingly simple method for comparing the yields from different savings accounts, regardless of the method used for calculating interest payments from banks or any other savings institution. Both the APR and the APY will be different from the associated compounded interest rates and they and their equivalent EPR and EPY counterparts will be affected by whether additional fees are levied by a lender or by a bank for their services. Obviously neither APRs nor APYs are given for simple interest because they are identical.

The equivalent EPRs for 2, 3, 4, and 5% are shown in figure 1-4 for from one month to 240 months (20 years). They increase with time. That is why lending institutions report the APR instead of the EPR on their loans; an APR is for only one year, as implied by the name itself. Thus such an APR is not indicative of the equivalent EPR for loans with terms longer than one year.

Calculation of the APY for a savings account is similar the calculation of the APR except that it applies to savings accounts instead of to loans.

As noted, reported APRs and EPRs may be different in different jurisdictions depending upon whether they require inclusion of fees and charges in its calculation. That is why they are most useful for comparison of loan costs only if they have common rules regarding any associated fees. Again the APR is identical to the EPR for one year for a loan.

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Figure 1-4. Equivalent Percentage Rate (EPR) for interest rates of 2, 3, 4, and 5% is given by the four curves from bottom to top in that order for from zero to 240 months for loans in which the interest is compounded continuously. APR equals the EPR at one year.

Another significant aspect of an APR is that it is announced only when required by a government, and it is greater than the advertised interest rate when the interest is compounded. Thus it is a warning that the interest rate on a loan is to be compounded.

The APY is the APR applied to a time restricted saving account such as a certificate of deposit. Banks advertise that the interest on their time restricted savings accounts, such as certificates of deposits, is compounded monthly, weekly, daily, or continuously and willingly display their APY for one year because it is greater than their certificate’s interest rate, which it is compounded but for terms no greater than five years. Therefore, aggressive bank advertising of their APYs is especially common when the prevailing interest rates are compounded but low.

As with loans, advertising APYs is beneficial because it also enables depositors to easily and directly compare the returns from various time restricted deposits as long as all APYs are for the same length of time. APYs usually are not given on certificates of deposit that have terms longer than five years because they pay only simple interest for terms in excess of five years. Compounding the interest any kind of savings account for longer time