The Economy Dies the Moment It Stops (2)

This piece is the latter part of Chapter 5 (2) of The Declaration of the Age of Physical Economics (Yoon Jong-won, Yoon So-ri, Yoon Jun). It is an academic exposition presenting the authors' physical economics hypothesis, and the body, figures, and citations follow the manuscript as written.

Microvasculature and the Back-Alley Economy: A Bidirectional Exchange System

For flow to occur, there must be a channel through which the flow can travel. In a national economy, the most decisive channel is the path of capital. Yet the large capital paths we commonly picture, the central bank, the commercial banks, and the flow of funds among large corporations, are in fact only a part of the channel. The place where real flow occurs is a far more slender channel: the back-alley economy.

The channel that runs from the central bank to the commercial banks is a channel of very large diameter. Once the policy rate is decided, the signal reaches the commercial banks within an hour. The channel from the commercial banks to the large corporations is also relatively large. A lending department can disburse funds within a few days. But for funds to reach households and back-alley shops, they must branch off from the large channels into ever finer ones. Commercial banks branch into regional banks, regional banks branch again into neighborhood branches, and at the last stage the funds arrive in the bank account of a back-alley shop.

The capital channel networks of the Korean and American economies are not made up of a single kind of channel. Five components, the central bank, the commercial banks, the neighborhood settlement network, the back-alley shops, and the recovery of bad debt, form one system. The first component is the central bank and the large financial institutions. It is the thickest channel of monetary policy, and the starting point of policy-rate decisions and the supply of funds. The second component is the commercial banks and the regional banks. They act like a thick smooth-muscle layer that receives funds from the large channels and distributes them regionally. The third component is the neighborhood branches and the card settlement network. It is the finest channel, made up of only a single layer of settlement system, and it is the domain where the core of bidirectional exchange takes place. The fourth component is households and back-alley shops. It is the micro unit where funds change from medium to deposit, and the restaurant of the self-employed owner who opened a shop in 1996 belongs here. The fifth component is the recovery path of bad debt and closures. It is a one-way channel that removes unrecovered bad debt and shuttered shops out of the system.

The Five Channels of a Nation's Economy: From Macro to Micro

The capital channel network reaches everywhere within a country. The number of business establishments in Korea reaches about 6 million. The number of business establishments in the United States is about 33 million. For all of these places to be supplied with funds, the settlement network and the capital channels must extend right up close to each shop. The number of card-settlement-network merchant members in Korea reaches about 2.9 million, and this enormous network extends up close to every shop, so that the system is built such that most shops are reached within one settlement unit from a policy-rate decision. If they were any farther, it would be difficult for funds to reach the shop through the settlement network.

Of the five components, the most decisive is the back-alley shop. A back-alley shop is not merely the end of a channel. It is an exchange system in which the inflowing flow and the outflowing flow occur simultaneously. A shop's bank account is made up of only a single layer of settlement system and is therefore very thin. Through this thin system, sales, rent rebates, and government subsidies come in from one side and spread into the shop, and through the same system, rent, food-ingredient costs, labor costs, and taxes flow out the other side and are recovered back into the market.

When the nineteenth-century British physiologist Starling formalized the physical law that governs the bidirectional exchange between veins and arteries, he showed that the difference between the pressure inside the capillary and the pressure in the interstitial space determines the direction of the fluid's flow. The same principle operates in the economic system as well. The difference between the balance inside a shop's account and the fixed costs the shop must pay each month determines the shop's operating direction. At one end of the shop, sales come in and the balance rises; at the other end, fixed costs flow out and the balance falls. Within one shop, flows in two directions occur simultaneously.

Simultaneity is decisive. The model this author verified with 690 months of data for Korea and the United States stands on this fact. When only one place was blocked, the system endured. Only when two places were blocked simultaneously did the system collapse. In the 3 cases of single blockade that recovered on their own, the American economy withstood all of them, and in the four Korea-U.S. cases of 2008 and 2020 in which dual blockade formed, the system collapsed in every case (1997 and 2003 are cases in which a single-blockade advance warning of the signal blockade alone led into crisis). Simultaneity is also the physical basis for the fact that back-alley-economy blockade occurs in both directions simultaneously within a single shop.

The fact is confirmed by satellite imagery as well. Immediately after the 1997 foreign-exchange crisis, the intensity of nighttime light in Korea fell by about 10.5 percent. It was the result of city streetlights beginning to switch off early and shop signboard lights beginning to go dark. The decline in light was already captured in the satellite data before the statistics were released. When the restaurant of the self-employed owner who opened a shop in 1996 failed to recover its sales in 1998 and began closing early each day, the satellite was recording the change in nighttime light intensity across the whole of Korea. Yet at that time there existed no diagnostic system to deliver this signal to the self-employed owner.

The Two Gradients Are the Same One Gradient: The Basis for Matching the Human Body and the Economy

Let us pause here to summarize. Earlier we examined a universal law that operates throughout nature, namely the general gradient law that there must be a difference for anything to flow. And we unpacked how the same law reveals itself within a nation's economy through the three gradients of capital pressure, the consumption-production gap, and credit expectation. On the gradient of capital pressure, capital flows; on the gradient of the consumption-production gap, logistics flow; and on the gradient of credit expectation, investment flows. These flows appeared to be flows handled separately in different fields, but going one level deeper reveals the fact that these flows are in truth two aspects of the same flow.

The reason a river flows from a high place to a low place is the difference in height between the two points. The reason capital flows from the central bank to the back-alley shop within a national economy is likewise the difference in capital pressure between the two points. The height gradient that operates in a river and the capital-pressure gradient that operates in the economy have different units of measurement and different flowing media, but the physical principle that creates the flow is the same principle. In both gradients, flow begins only when there is a difference, and when the difference disappears, the flow stops. In both gradients, the speed of the flow is determined by the shape of the channel, and in both gradients, when the channel narrows, the flow decreases steeply. The physical law of flow that the two gradients follow is the same law.

That is the reason we call them the same kind of gradient system. Rivers, stars, and the economic system are made of entirely different materials, but they are all the same kind of system in which a flow created by a gradient is carried out through a medium. In a river, water is the medium; in a star, light and heat are the medium; and in the economic system, capital, logistics, and credit are the medium. The media differ, but the reason the medium flows, the way the speed of flow is determined, the point where the flow is blocked, and the way the system halts when the flow stops all operate on the same physical structure. This author defines this same kind of system as a gradient-driven flow system, and has established the fact that both the national economy and the human body belong to the same system.

A decisive fact follows from here. The human body, too, is the same kind of gradient system. The reason blood flows within the human body is the difference in blood pressure between the heart and the periphery; the reason oxygen flows is the difference in oxygen concentration between the lungs and the cells; and the reason calcium flows is the difference in calcium concentration between the bone and the cells. Every gradient that operates within the human body follows exactly the general gradient law examined earlier, and operates on the same kind of gradient system as the economic gradients examined here. Rivers, stars, the economic system, and the human body are all four different surface manifestations of the same gradient system. The materials differ as river water, light, capital, and blood, but the physical law of the flow is the same law, and the academic structure in which that law operates is the same structure.

That is the reason the Korean and American economies and the human body match. The two systems have different media and different units, but because they are the same kind of gradient system, the shape of the flow is the same, the point where the flow is blocked is the same, and the physics by which blockage leads to a system halt is the same. Just as, within the human body, when the microvasculature narrows the cells beyond it begin to necrose from lack of oxygen, so within the national economy, when the back-alley capital channel narrows the shops beyond it begin to close from lack of funds. Just as, within the human body, when two channels are blocked simultaneously the patient reaches death, so within the economic system, when the two channels of the capital-inflow path and the recovery path are blocked simultaneously, the whole system collapses. The reason the two systems show the same appearance is not coincidence but the fact that the two systems are the same kind of system operating on the same physical law.

Let us note the academic honesty here. The intuition that the Korean and American economies and the human body resemble each other is not new. As examined earlier, Quesnay in 1758 first drew the economy like the body of a single person; the nineteenth-century British economist Marshall likened the economy to an organism; and the twentieth-century American economist von Neumann treated economic growth with a biological growth model. The intuition itself has existed for 250 years. But that intuition had never been formalized into an academic proposition. The fact that the two fields are the same kind of gradient system, that is, the fact that the matching of the two fields is not a metaphor but an academic isomorphism, had never been supported. The diagnostic system this author has established is an attempt to erect an academic foundation in that 250-year-old empty space, and this one book is the flow that unpacks that academic foundation one step at a time.

The chapters that follow are the process of verifying the academic basis of the matching one step at a time. We unpack the fact that the human body and the economic system stand on the same equation through seven grounds and a one-to-one mapping diagram; we examine the four media of cash, savings, loan interest, and consumption decline that operate in the same form in both systems, and the four triggers of deficiency, inflammation, acidosis, and hypoxia; we confirm the academic formulation of the dual blockade that operates with the same multiplicative structure in both systems; and we confirm the crisis pathway that proceeds through the same five stages in both systems. Every point at which a diagnostic tool established in one field applies directly to another field is an indirect proof of the fact that the two fields stand on the same academic structure, and the result this author verified with 690 months of data for Korea and the United States supports the indirect proof once more upon data. The verification result that all 4 crises over the 690 months were caught in advance and that not once in the 684 non-crisis months was a false alarm raised is evidence of the fact that a diagnostic tool established in medicine applies directly to the diagnosis of a national economy.

The two gradients are the same one gradient, and the two systems are the same one system. Here lies the reason the economic system and the human body match, and this one book is the flow that verifies the matching one step at a time. The conclusion of the matching is the very proposition we will meet at the next stage, the proposition that what flows lives and what is blocked dies.

If It Flows, It Lives; If It Is Blocked, It Dies

A nation's economy is alive only upon flow. As long as capital flows from the central bank to the back alley, logistics flow from the harbor to the home, and credit flows upon expectations about the future, the economy is alive. The moment the flow stops, the economy halts. Therein lies the reason the first picture Quesnay drew in 1758 remains valid even now, 250 years later.

Yet the five schools of Keynesianism, monetarism, MMT, neoclassical economics, and Minsky failed to see how the flow is blocked. Keynes saw only the quantity of demand; monetarism saw only the quantity of money; MMT saw only monetary sovereignty; neoclassical economics upheld the assumption that the market strikes its own balance; and Minsky failed to see where debt is deposited. Nowhere in any of the five schools was there a tool to save Korea's self-employed. That empty space is the story to be dealt with in the next chapter.

When the Korean self-employed owner who opened a shop in 1996 opened the shop door, the owner was not conscious of the fact that the shop was floating upon the three flows of capital, logistics, and credit. And so when part of the flow began to stop in 1997, the owner did not know its cause. Now, 30 years later, this author has caught the stagnation of the flow with 690 months of data for Korea and the United States. If the flow can be seen in advance, Korea's self-employed may no longer be struck by shocks without prior warning. But to do so, we must first answer the question the five schools failed to answer for 250 years, how the flow is blocked. In the next chapter we unpack that answer in earnest.

References

1. Brunnermeier, M. K. (2009). Deciphering the Liquidity and Credit Crunch 2007-2008. Journal of Economic Perspectives, 23(1), 77-100.
2. Onsager, L. (1931). Reciprocal relations in irreversible processes. Physical Review, 37(4), 405-426.
3. Quesnay, F. (1758). Tableau Économique.
4. Reinhart, C. M., & Rogoff, K. S. (2009). This Time is Different: Eight Centuries of Financial Folly. Princeton University Press.
5. Starling, E. H. (1896). On the absorption of fluids from the connective tissue spaces. The Journal of Physiology, 19(4), 312-326.