Profits are sales minus costs. The costs reflect expenditures of money made in the past, sometimes, as in the case of depreciation on buildings, decades in the past. In contrast, the sales reflect money spent in the present, or at least in the current year.
To the extent that the quantity of money and thus volume of spending in the economic system increase over time, sales increase correspondingly, which means that profits increase correspondingly, because the costs are determined by expenditures already made.
The percentage rate of increase in the quantity of money and volume of spending can be understood as adding an approximately equivalent percentage to the rate of profit. Thus if money and spending increase at 2% per year, the rate of profit, instead of being, say, 5%, will be 7%.
To understand this point, imagine that without any increase in money and spending, a merchant would buy his goods on a given day for $100, and sell them a year later for $105. But if over that year there is a 2% increase in money and spending, he will sell his goods for 2% more.
His profit, instead of being $105 minus $100, will be $105 x 1.02 minus $100, i.e., it will be $107.1 minus $100—approximately 7% instead of just 5%.
No doubt surprisingly to many, insofar as profits are subject to taxation, the more rapidly the quantity of money and volume of spending increase, and the higher the rate of profit becomes, the worse things are from the perspective of real wealth and income.
This is because the increase in money and spending raise prices. The taxation of profits, however, prevents the funds accruing to sellers from keeping pace with the rise in prices. Their funds grow only to the extent of what remains after the payment of taxes.
For example, imagine that money and spending increase by 10% per year and that prices rise by 10% per year. The rate of profit will be equivalently higher.
But if half of those profits are taxed away, business firms are left with sales proceeds only 5% higher and yet must pay prices 10 percent higher.
This is a major way in which inflation—the government’s expansion of the money supply—destroys an economic system. It creates the appearance of business prosperity along with the fact of general impoverishment, which results in blaming poverty on business and profits.
The solution is a money the government cannot create: namely, gold. The gold standard must be an essential part of the program of all advocates of capitalism.
Originally published at the blog of George Reisman. Copyright 2019 George Reisman. All rights reserved.