It deserves to be remarked, perhaps, that it is in the progressive state, while the society is advancing to the further acquisition, rather than when it has acquired its full complement of riches, that the condition of the labouring poor, of the great body of the people, seems to be the happiest and the most comfortable. It is hard in the stationary, and miserable in the declining state. The progressive state is, in reality, the cheerful and the hearty state to all the different orders of the society; the stationary is dull; the declining melancholy.

 Adam Smith¹

The year 2007 marked the beginning of a world economic crisis that we are still be recovering from. The financial system of modern capitalism not only failed to prevent this crisis but also caused it to explode dramatically.

The goal of this work is to design a new financial system that is fundamentally different from the existing one. It is a financial system of a new formation that we call a Perfectly Competitive Market, or PCM. I would like to note that from a theoretical viewpoint this design is the only possible option, despite the abundance of theoretical and practical approaches to economics.

One fundamentally, though not the only, important feature of the new system is a separation of the legacy combined credit and payment system into two parts: provision of credit and processing of payments. In this book, we introduce our new financial system in the following order: Chapter 1 focuses on the national payment system and issuance of money, Chapter 2 describes changes in the credit system, Chapter 3 shows how national monetary systems can be linked and Chapter 4 contains some additional considerations for PCM.

Our proposed transition from the traditional three-level, heterogeneous credit and payment system (central bank ↔ other banks ↔ market participants) to our new, robust two-level system (central bank ↔ all market participants) can be difficult to understand. This is not because our new system is complex, but rather because of the convoluted nature of the existing system where many details appear to be totally different from how they really are. These details may look different depending on your chosen viewpoint, bringing to life certain all-encompassing categories, like “money stock”, that contain some very diverse components.

Most people don’t understand even some of the basic elements of the existing financial system. To appreciate the simplicity of our new proposed system, and to show that no critical functions are being sacrificed in the transition to it, we will have to take an exploratory walk up and down the legacy financial system.

Among byzantine labyrinths and curved mirrors of the legacy financial system, some people are making serious money. Given my own entrepreneurial past, making money doesn’t concern me anymore. However, the money made by exploiting certain features of the legacy financial system adds the burden of extra costs to the “real” (non-financial) sector² of entire national economies, which is a serious issue. Furthermore, the legacy system contributes to moral decay in society by questioning things like elementary frugality on our planet with its limited natural resources, efficiency of private property institutions and even the creative nature of our civilisation.

In the course of our exploratory walk, our fundamental concepts about the existing financial system, and the economy in general, may not completely agree with the reader’s view (possibly due to my atypical background for a theoretical economics author). Having spent my economic “childhood” studying at Moscow State University, I jumped into my economic “youth” by becoming one of modern Russia’s first entrepreneurs back in 1989. Given that in the subsequent 14 years I “grew up” to manage a few firms that were quite noticeable in their respective sectors, the nuances of marketing, procurement, finance and other kinds of hands-on economic activity have indeed become part of my identity.

In lieu of using the frequently abused term “experience”, I will try to illustrate what I am saying using a certain “database” (in this context meaning all the data and knowledge of an individual person rather than a reference to rows of data stored in a computer). A popular saying attributed to Archimedes is: “Give me a place to stand on and I will move the Earth.” I would argue that science could use a more fitting maxim: “Give me a database and I will explain everything.” However, the means for obtaining this “database” fundamentally differs between natural and social sciences. In the former, the database is often assembled in a laboratory setting by using instruments to measure and collect primary experimental data, both inside the laboratory and outside in the world. The better the laboratory is equipped, the more comprehensive and precise is the database, and potentially the more qualified are the research scientists. Conversely, if your laboratory and university run on a shoestring budget, you are unlikely to make progress or produce talented scientists. Let us also point out that the data used in natural sciences can be easily structured and formalised. This in turn opens up two fundamental options. First, one can gather, store and transmit data. Second, one can use formal mathematical methods to analyse the data – it would be impossible to imagine modern theoretical physics without the extensive use of advanced mathematics.

In social sciences, or at least in important fields such as political science and economics, we have a different situation. Here, primary experimental data is represented by people’s actions and their consequences, while academic institutions often find themselves isolated from the data. This data can only be collected in person and “in the field”, and it may be subsequently transformed inside an observer’s brain into a complex array of conditioned reflexes (later we’ll show that the said database-building transformation is not guaranteed by fulfilment of these two conditions). The simplest practical corollary of this feature characteristic of social science institutions is that an advanced education in political science or economics may not be required to achieve the highest degree of qualification. That is, to become a professional politician or entrepreneur, it is not necessary to have a synonymous education. On the other hand, no matter how much you invest in social science laboratories, the chances of producing a future Vladimir Putin or Bill Gates will not materially increase.

A person’s actions and an observer’s (or rather, a participant’s, as distinct from natural sciences) conditioned reflexes cannot be formalised, making the collection of primary data (or actions) and transmission of a participant’s conditioned reflexes resulting from these actions nearly impossible. Advanced mathematical methods, with a few rare exceptions, are also not applicable to the field of theoretical economics. Later in this book we will show how these methods can be selectively applied to a socialist economy.

Let’s revisit our earlier postulate of “Give me a database …” which is nothing but a buzz phrase; nobody can know everything and even a researcher armed with this “database” is not guaranteed to draw correct conclusions from the data. First, our researcher should use his built-in biological “computer” to run clustering and regression algorithms in order to sift through massive amounts of primary experimental data, identifying key factors influencing the process, and then establishing a cause-and-effect relationship between certain data elements. In reality, researchers do not have a complete database of this sort (while you are reading this sentence, there are millions of economic events happening in the world). They are forced to use data with varying levels of quality and confidence. In this case, the researcher’s qualification becomes very important.

People start leaning towards certain professions while still in primary school. Given the rigorous requirements for future scientists, they must continuously meet ever-increasing specific qualifications. To be able to work with the primary economic database, economy practitioners also need to have certain qualifications. However, their analytical brain activity is often accompanied by processing hard-to-formalise data obtained using their five senses, which is something computers still cannot do.

You might have asked yourself at least once why, in some firms, the people who appear to be intellectually gifted are working for nondescript owners. A younger employee might argue that “Everything has been divided, so I put up with this.” I would say that this situation is realistic, but the answer is stereotypical. In the 1990s, we observed the division of labour happening quite naturally in nascent Russian businesses. Leadership roles were assumed by people meeting the “entrepreneurial” qualifications, i.e. capable of processing primary economic data to make correct decisions. This selection of entrepreneurs has not disappeared, but now it happens much more slowly and is hindered by the dominance of large firms in the current economic formation (we are going to address this extensively further below).

We are not talking about some “all-seeing eye” of fairness, which would reward every new entrepreneur according to their talents, but rather we observe that, as a rule, successful entrepreneurs do meet the above “entrepreneurial” qualifications. People sometimes exaggerate the importance of exclusive information used by top managers to make business decisions. In reality, there are individuals around the boss who have complete or nearly complete information, or else the firm would be grossly mismanaged. However, it should also not be taken for granted that these informed professionals will make timely and correct business decisions, given the variety of input factors and the potentially high cost of mistakes. We should note that stereotypes often accompany bad decisions, including “do nothing” scenarios, as comparable business situations are generalised and nuances are ignored. Having incomplete information often precedes this pattern.

In a practical economy, numerical information (including prices) is not only mandatory but also the most important component of the seemingly verbal process of formulating and sharing business information. Managers’ qualifications are tested by their accurate “digitising” and evaluation of input information to make correct decisions. In a nutshell, a managing owner’s database is formed in the following order: processing of primary (not obvious) data about people and their actions → forming a more precise database (all learned reflexes) → price management → refining the database which consists of learned reflexes. If prices are managed with a positive bottom line, our market participant is confirmed to have a certain understanding of the structural links between the primary database components in a chosen economic activity sector. Profit (or loss) is the ultimate litmus test to distinguish “I understand this” from “I am watching this.”

Now, we may draw a simple but initially not so obvious logical conclusion: our “database” will display the best precision when it is formed in the heads of entrepreneurs. Any learned reflexes formed in the economy, while being directly connected to the gains and losses of market participants, are necessarily based on the outcomes of numerous events and decisions made primarily by the active owners. It works in the following order: events and decisions → business gains and losses = entrepreneur’s income → learned reflexes are formed without any distortions.

Coffee break: you might have heard funny stories about how “New Russians” loved to buy the most expensive things available. There is a psychological underpinning for this behaviour. There is not only a desire to stand out (“conspicuous consumption” a.k.a. the Veblen effect), but also a learned reflex of price management. Entrepreneurs working with consumer goods know well enough that setting prices incorrectly is akin to throwing money away. Yes, some people may be willing to pay higher initial prices, but if buyers learn that quality does not correspond to a high price, they will develop an adverse reaction, so that even a subsequent price lowering might be interpreted as a sign of weakness. In the end, simple arithmetic calculations show that it would be more profitable to set lower prices from day one. Thus, faced with new and unfamiliar goods, entrepreneurs (especially new rich ones) may believe that sellers who set the prices think the same way. Indeed, prices for mass consumer goods follow this logic, whereas peddlers of luxury goods are very happy to attract such consumers. The sellers guess this psychological twist, perhaps intuitively. Although the Veblen effect is stronger, these nuances exist as well. We may add that when dealing with goods that they know inside and out, these same heroes of funny stories would often demonstrate their nearly flawless understanding of how things work.

Summarising the above, we can say that observation, participation and price management represent different levels of primary database qualification, because they assume different skill levels required to understand the data hierarchy and cause-and-effect relationships. This generalisation is by no means complete as “databases” can be vastly different. For example, a database formed while managing a restaurant will differ from a database formed while managing a conglomerate. A database formed while managing a commercial bank may help develop analytical rather than theoretical skills.

Having no access to a primary “database”, theoretical economists usually work with existing theories, statistical data and observations. It is a certain “view from above”, while this book is largely a “view from below” driven by primary and fundamental data. Thus, do not be surprised if some of the material contradicts your familiar narratives. This may be due to either error on my part or your false stereotypes. One way or another, in this book I promise to tell you something new (including comments on some well-known economic theories). Regardless of your own views, it will just be a different perspective.

Along our little journey you may encounter certain inconveniencies. It is impossible to cover every level of both the old and new systems at once, and likewise it is impossible to stay on one side and completely ignore the other. Even for the simplest element of a financial system, explaining the finest theoretical points will demand tracking of interactions arising in several diverse aspects. In any economic system that we set out to either describe or mention, there is a myriad of dependencies that is difficult to describe, just as with an analogy of light bulbs being turned on sequentially. A set of theoretical generalisations does not easily match an actual flow structure, even if the latter is simplified to a rough draft. Therefore, to preserve consistency in our narrative while keeping it true to the actual economy, we will use footnotes extensively (and the text in footnotes is often no less important than the main contents).

This abundance of footnotes is a known drawback. However, if I (and not some other author who might be more skilled in structuring the information) were to give up on footnotes, the text of this essay would be harder to understand. This book also offers a collection of applied essays (Chapter 4), Conclusion and a glossary of terms. A lot of seemingly odd and insignificant content will be better understood once you’ve read the whole book. These reservations are even more appropriate given that we not only construct separate national financial systems, but also link them together in the framework of a global financial system in Chapter 3. However, that is not all. We will see that changing the current system to a new one is consistent with the development of economic laws of our civilisation. The new system we’ll design in its basic features will not be capitalism in its (yet another) modification,³ nor will it be a socialist or a communist formation, but a more perfect, market-based formation.

Therefore, different from most other market economy studies, explicitly or implicitly aiming to modernise capitalism, our intentions towards capitalism are purely diagnostic ones. We focus on discovering fundamental costs of modern capitalism while presenting a new formation that by design would be free from these costs. This study will require using a somewhat unusual methodology. To a large extent it involves not the categories themselves, but firstly, interpretations of these categories, and secondly, a hierarchy of these categories. To put it simply, we place different accents on a generally traditional system of categories. Even simpler, we use common bricks to build a seemingly unusual home that would be much more durable and cheaper to operate compared to our current one. Our key secret to achieve this goal is not to rearrange the bricks but – continuing the construction analogy – to make good use of scientific and technical progress.

The term “formation” was introduced to theoretical economics by Karl Marx. Besides this fact and besides using some formation names originating from Marx’s socio-economic theories, this book has no meaningful intersections with Marxism. However, it is worth mentioning materialism as a methodology that I support, not in the philosophical sense of the word but literally. From my point of view, Marx’s materialism was a temporary stage in the materialistic perfecting of theoretical economics and philosophy. In the 18th and 19th centuries, the scientists’ fight with the religious interpretation of the structure of the world led them to radical demonstrations of a person’s independence from the church. As often happens with radical changes, economic theories took a turn in the other direction. In lieu of God, man was endowed with mystical powers to create some speculative “value”, allegedly hidden in the product itself and thus distinct from the product’s price, which is also routinely called “value”, with the key difference that price is visually represented by a certain monetary equivalent. Belief in the existence of some “flowing clots” or “abstract human labour” seems to be essentially close to religion. No wonder that in all 14 years of my entrepreneurial “lab research” I have not seen anything like this. This study is based on the realities of the world around us, on materialist categories.

As it can offend the ear to juxtapose “matter”, objectively existing and “categories” (see Glossary), subjectively represented by man, I will explain the materialism of the category I understand as the veracity of human perception (either sensual or numeric). To paraphrase, you and I can have different opinions about a chair I am pointing at – Is it good or bad? Do we need it or not? – but we still agree that it is a chair. This definition is insufficient to explain “everything” in the universe. However, it should be enough to deal with economic realities linked to decisions being made by one exact biological species, Homo sapiens sapiens (hereafter referred to as Homo sapiens), on planet Earth. At least from the dawn of human civilisation to our present day, materialism in this narrow sense is a prerequisite to enter the real economic world.

This definition of categories’ materialism makes the use of reflections and representations as basic categories impossible. Ideas do matter, and humans not only can but must think in order to increase their share of material wealth. Thoughts themselves originate from very material brain activities. However, before they manifest themselves in a material form adequately perceived by other people, thoughts can only be a bridge to the economy. For example, while intellectual property is not yet embodied in a patent registration, book publication or in another materialistic event obvious to a bystander, the fruits of thought will not become part of the economy or part of actual events.

Not everyone is likely to completely share my view on the “materialistic” criteria with this very succinct description, so let me point out that I am simply describing the boundaries within which our study will unfold. All basic categories in it are materialistic exactly in this mundane sense. They represent material objects and numbers, whose objectivity should not be doubted, even if the reader does not agree with our reasoning about the cause-and-effect relationships among these categories. Below, we will lay out some basic categories of our study, with very minimal explanation at this stage. In this introduction, we are going to elaborate on only one category, namely “property”. When saying “property” without any explicit decoding, we assume one of the following two fundamental meanings of it.

First fundamental postulate: property is something that belongs to people (in the form of private or collective property). To set the proper tone, let us reiterate it as follows: property is something that belongs to Homo sapiens, a biological species dominating planet Earth. Everything that is used in our economy belongs to the human population. This biological emphasis is strong. If we apply the “right of ownership” concept with a legal tone, it may feel like there is a certain higher authority that confirms the rights of Home sapiens for planet Earth or at least for its biosphere. In fact, humans have received this property due to natural selection and if we try to find any “right” here, it would be the “right of might”, which thus deviates from the legal sense. We can add that the stated tie to biology is not in the way of our study as it does not impose obligations on it, unlike mathematics or jurisprudence. We use biological references mainly to point at an “umbilical cord”, so later we’ll talk in detail about biology as a fundamental science for theoretical economics in such a fundamental thesis as “Psychology and rationality in theoretical economics …”.

Now that we have introduced the “property” category with a biological emphasis, it is fitting to introduce “the right of ownership” with a clear legal emphasis: inside the population of winners, relations between the owners need to be regulated. However, there are some nuances here. There are relations between nations and within the nations. In politics, especially in international relations, the right of might often dominates the rights of owners and the winners write their own laws. As human civilisation develops, this situation evolves, but violence still takes place when certain people do not recognise the rights of ownership of others. Two main manifestations of such violence are warfare and criminal offences. Let’s leave these to political and legal scholars and return to our description of ownership as it applies to the economy, given that the above paragraph has simplified our task of formulating the next important statement.

Second fundamental postulate: in the economy, owners recognise the rights of other owners. The author is not to be considered naïve – respect for rights to property in the economy can depend on the level of civilisation development. However, this respect for owner rights in the economy at practically any given moment has been much higher compared to the respect for these rights in politics, to say nothing about criminal offences. There is a simple but very important biological explanation for this phenomenon. Species other than humans might also have “economies” as they produce (mainly harvest but sometimes also process) certain products, at times even using a simple means of production. However, humans became smart enough at a particular stage of development to not just steal or confiscate another family’s property but, recognising the rights to property of others, to exchange it for something they already have.

A macroeconomy, being a set of exchanges or deals, is a “temple” of theoretical economics in our framework that we’ll explain shortly after decoding the four basic types of property. We put “temple” in quotes simply because we won’t need to use any mysterious substances to explain “value” creation in a microeconomy. Instead, we use good old price, which is easy to understand and calculate.

Let’s list the primary, fundamental categories of our study (here, “primary” does not have any special methodological meaning; we are just saying that some of these categories break down into other fundamental categories): property, exchange (deal), property increment, property alienation, price, managing owner, physical turnover in monetary terms, credit turnover, costs, cost regulators⁴ of managing owner and profit.

“Property” contains four basic elements: goods, people, land and money. “Goods” are commonly referred to as commodities in deals. For ease of understanding of the text by English-speaking readers, I use the term “goods” routinely, unless minor loss of rigor is crucial here.⁵ “Money”, in turn, breaks down into money as credit and money as payment.

We consider bilateral (purchase and sale) and unilateral (lease) basic exchanges (deals). We’ll use symbols “↔” for bilateral and “←” for unilateral property alienation. The arrow shows the direction of property alienation between managing owners. When crossed with basic ownership types (C for commodities, P for people, L for land, M_C for money as credit, M for money as a means of payment), we get the following four basic deals:

       Purchase and sale⁶: C ↔ M

       Lease: P ← M, L ← M, M_C ← M

In all three basic lease deals, only M (money as a means of payment⁷) is being alienated. M serves as the price of leasing people, land and “money as credit” in these deals, also known as wages, rent and interest, respectively. These are basic cost types for a managing owner and can be treated almost as basic cost regulators, but in a strict sense, these are the rates of wages, rent and interest. This difference is most conspicuous in credit deals⁸ whereas in the two other lease deals it is less visible. Thus, examples of basic cost regulators proper are the price of hiring a worker for a unit of time (further referred to as “wages”⁹), the price to lease a unit of land for a unit of time (further referred to as “rent”¹⁰) and the price of borrowing a currency unit for a unit of time (further referred to as “interest rate”). The fourth basic regulator is a kind of “money as a means of payment” in the one and only deal where money in a sense can be the price of itself, namely the price of a national currency unit expressed in a foreign currency (further referred to as “cross-price”). If you have paid attention, the last basic regulator is not related to lease deals but is a specific case of the purchase and sale deal (international currency exchange), where foreign currency plays the role of specific commodities. This should not offend the ear if we assume that within a national economy there cannot exist money and some “other money”. Only one thing can be designated as money. This theoretical postulate would need to be stretched to apply to capitalism, but in our new formation it gains visual rigor.

Negative profit (or loss) is yet another basic category that is a variation of profit and serves as the final cost regulator of a managing owner. Negative profit can complicate, and in extreme cases (one time or cumulatively) stop altogether, the managing owner’s activities at the helm of the firm, as these are not effective from a market viewpoint. This final cost regulator is the “fifth element” having a direct impact, a net sum of all other basic cost regulators. If other cost regulators are formed in particular deals (for instance, the interest rate in money loans and wages in a labour hiring), the negative profit is formed as the bottom line of all preceding deals. As a rule, revenue (and thus forming the final profit) takes place in purchase and sale deals for non-banking firms and in credit deals for commercial banks. However, costs are directly impacted by many other diverse deals.

You might have paid attention to one common feature that unites all our cost regulators: they are all expressed in terms of money and on all occasions, money is used as a means of payment. Therefore, all of them are either market-driven prices as basic cost regulators, or an aggregated total sum as a final cost regulator obtained by using simple arithmetic operations. This observation will help us further refine the scope of this study, e.g. to exclude barter deals where no money is used at all. These deals certainly make their own economic sense as all the people, including entrepreneurs, do exchange mutual services. Our main reason to narrow the scope this way does not stem from neglecting barter but rather from the inability to apply scientific methods to it. Without money involved, we don’t have a common measure to evaluate the barter.

You won’t find any sophisticated mathematics in this book. Apart from simple arithmetic operations used by market participants to account for their business processes, and a technological “black box” of production where mathematics is used by engineers, more complex mathematical models are always fraught with varying degrees of conditionality and assumptions that formulas or graphs represent actual, real life processes. Not everyone will agree with this emphasised disinterest in mathematics, especially given its universal use in theoretical studies of recent decades. One way or another, we will only be using precise equations, specific economic equivalencies produced in the millions by everyday economic activities. These are understood as deals in which managing owners¹¹ evaluate different kinds of property and equate them by agreement. In my mind, there are no other theoretically important precise equations in economics that would compare different kinds of property, or functions describing precise proportions between them. Engineering, logistics and accounting calculations have important practical (applied) meanings, but not theoretical ones. With that said, for our precise reasoning, we’ll use a set of deals where prices expressed in money are forming.

As previously mentioned, we will call this set of deals a macroeconomy. We will use this term only to describe a significant sector of a national economy. This definition is narrower compared to the commonly accepted understanding: “an object being researched by macroeconomics” (in both plain and scientific lingo, it is often also called “macroeconomics”). Meanwhile, the traditional term “macroeconomics” in its alternative meaning of “an object to study” looks more like what we call in this text a “national economy”. As the latter is naturally the main subject of our theoretical study and given that the essence of theoretical postulates is formed in a macroeconomy (let me remind you that in our study this is defined as a set of exchanges), the difference between the traditional definition of this term and ours is not crucial. But it does exist, of course.

Besides macroeconomy, a national economy contains some other fundamentally important sectors, including the following “reproductive” blocks. There is a microeconomy proper (goods and services), households (people) and a government in a broad sense, including the central bank (money). The fourth basic type of property – land – unfortunately does not reproduce. Unlike relatively static reproductive blocks, a macroeconomy appears to be a set of operations (processes) which maintain economic connections between blocks as well as within them.

To get a better visual understanding of a macroeconomy, let’s portray a deal as the movement of money accompanied by (a) the movement of property that is changing hands in exchange for this money and (b) the mutual exchange of relevant information. Movement of non-cash money here is facilitated by commercial banks.¹² As for the movement of property and information, these are largely performed by third parties specialising in transportation, logistics and communications.¹³ Note that money transfer can take place entirely within a firm. Likewise, transportation, storage and communications may sometimes be classified as internal firm operations. No deals take place in this case and all these events fall within the scope of a microeconomy.

That is, the indication that – from an in-kind point of view – reproductive blocks can be thought of as static property sets and a macroeconomy can be represented as a set of operations needs to be accompanied (as often happens in economics, especially when using in-kind categories) with a “generally” disclaimer. There are commercial banks, with all the property they own, that do not fit our definition of a macroeconomy but in fact they are clearly macroeconomic enterprises (one might be tempted to place commercial banks into some reproductive block labelled “money” but later we’ll explain our reasons for not doing this). There are also certain operations that look macroeconomic but cannot be properly classified as such. That’s why the best possible definition of a macroeconomy is as follows: a set of deals where prices in monetary terms are formed.

The most diligent study of a macroeconomy in a sole historical epoch will not lead to the discovery of a system of fundamental economic laws. It takes less effort and ensures more precision to compare the present day macroeconomy to one of the past. The kinds of deals and prices, as well as basic property types, have been changing (functionally or materially) significantly as human civilisation developed, driven by scientific and technological progress. By the way, modern economists enjoy an undoubted advantage over the great theoreticians of the past. None of those at the peak of their intellectual maturity had comparable opportunities to obtain and analyse current economic data, nor did they know what real economic life would look like at the turn of the millennium, nor imagine what technological achievements directly impacting economic development would be available.

Studying how basic categories and links between them evolved over time allows us not only to refine the principles of changes of an economic epoch (formation) but also to make an educated guess about the look and feel of the next formation. Here, I will get to the point and set out the general scheme of historical-economic logic that, in my opinion, forms the cornerstone of the dialectical unity of our civilisation’s economic development.

In the most stringent way, economic formations are defined using the concept of freeing cost regulators, which are superimposed on the evolution of the physical form of money. This classification is easier to understand once we pre-examine the historical metamorphosis of the basic types of property. Basic resources – people (P), land (L) and money as credit (M_C) – are gradually used less and less by managing owners in the outright private property mode.¹⁴ Until they are barred (i.e. until certain resources are classified as non-reproducible within a microeconomy by law), corresponding economic formations are called slave-owning (P), landowning (L) and capitalist (M_C), respectively. Conversely, commodities (C) are used (as they can be reproduced in a microeconomy) by managing owners in the outright private property mode. When this practice was questioned and barred, socialism was born. The essence of basic resources’ metamorphosis is even easier to understand if we note that resources are gradually (step by step) shedding their commodity component. During the last few thousand years, when it made sense to talk about the economy, people always remained people in their physical form but, for economic purposes, slaves were essentially a commodity and human surrogates. Thus, a purchase and sale deal P↔M was often used in lieu of a basic lease deal P←M (despite the fact that C↔M is a basic purchase and sale deal). As for the M_C part, under capitalism the use of commodity and money surrogates (in general, securities; in this case, securities with a credit component, as we are talking about money as credit) has gradually grown to a disproportionate size, even for capitalism adherents.

This simplified understanding, described in the previous paragraph, does not include socialism, indirectly suggesting its optional nature for Mediterranean civilisation, whose development (at least from a mere economics viewpoint) eventually came to determine the course of global economic development. For now, staying within the scope of this simplified understanding in order to more easily classify formations, let’s write down in one column our four basic economic deals:

       C ↔ M,

       P ← M,

       L ← M,

       M_C ← M.

On the left side, we have all the resources getting rid of their commodity component over the course of economic evolution as well as the commodities themselves. On the right side, there is only money. In the scope of this study, we will use the definition of money as valuable numbers used as a means of circulation (details are in Chapter 1). Over the course of evolution, money gradually shed its goods form (this form is increasingly less dominant than the numerical essence of money – it is impacting the value of money less and less) in this simplest physical understanding: gold (metal) money → paper money → digital records (non-cash money).

There is one subtle moment that illustrates the difference between commodities and goods: while analysing metamorphoses on the left side of deals, we noted a “commodity essence”, but in the preceding paragraph we spoke about a “goods form” of money. In the first case, the physical form of these property types is not essential. More important is the level of rights on this property bestowed on managing owners by law (full rights or limited rights). In the case of full rights, this property gets its “commodity essence” that under our PCM model, the supreme formation, will be reserved (within a single national economy) exclusively for commodities proper. Conversely, change in the physical form of money is deterministic when we observe its metamorphoses. As the physical form does not depend on the type of deal (remember that a good becomes a commodity only in a deal), it would be more accurate to talk about the “goods form”.

The emergence of money as numbers blatantly demonstrates the transition of people from the very first and longest formation (traditionally called primitive) to economic formations proper, and for Mediterranean civilisations this would be the slave-owning formation. It is clear that the latter (slave-owning) formation is called this particular name not because there was no slave ownership in the former (primitive) one. It is less obvious that while using livestock, seashells and other goods as equivalent exchange media was undoubtedly a necessary step towards using money, the very first real money was metal. Even when this money had no minted denominations, comparing the weight of homogeneous coins made economic measuring much easier and facilitated the work of the basic cost regulators.

The evolution of money also played a major role in the emergence of two intermediate formations (the fifth and the sixth): paper capitalism¹⁵ and socialism, respectively. While the emergence of socialism is best described by the abandonment of the final cost regulator (negative profit), the evolution of money should be exclusively¹⁶ credited for turning “gold” capitalism into paper capitalism. The latter itself is an intermediate formation, due to the intermediate nature of paper money in the transitional process from gold to non-cash money. The simplest historic timeline shows the transitional nature of paper formations: compared to the length of dominance of the gold (metal) standard and the length of dominance of the future non-cash standard, paper capitalism has a very limited life span.¹⁷ It would seem to be a tiny twist in history, especially when paper capitalism did not reveal itself until the 1930s and the dollar was tied to gold until 1971. But when nascent paper capitalism triggered the crisis of 1929, the whole system of gold capitalism’s rules and logical ties that had formed in both theoretical and practical minds suddenly stopped working as expected. All the mirages and other specifics of a modern financial system that we discuss in this book are manifestations of this paper capitalism, and are very different compared to its older brother, gold capitalism.

Having paid attention to the physical evolution of money, let’s return to the regulators (basic and final) that exert considerable influence on the transition from one formation to another. This is even more relevant for our study as the freeing of the last two cost regulators forms the essential part of the forthcoming transition to the next formation.

Once again, let’s write down in one column our four basic economic deals, but this time adding the names of the three prototypes of basic cost regulators (functional names of money as a means of payment) next to the corresponding lease deal:

       C ↔ M;

       P ← M, wages;

       L ← M, rent;

       M_C ← M, interest.

Functional varieties of money as a means of payment in lease deals (wages, rent and interest) have always or nearly always existed, but for each one of these there was (or will be) a historical period when its importance as a basic cost regulator was critically important. Deal C↔M gives us the remaining basic cost regulator, or cross-price (the unique nature and the theoretical tie mechanism to the C↔M deal was explained earlier). The deal C↔M also has the last say when a final cost regulator (negative profit) is being formed at firms.

In the previous book¹⁸, we dwelled extensively on the basic features of several formations and I faced the need to cover these features in more depth, given the abundant variety of historical material. This meant an extra year or so of work and it substantially increased the text volume, inevitably distracting us from the main goal: a theoretical justification for the transition from the existing formation to the next one. Therefore, in this book, only the Introduction will contain this material. Here, I will point out an important change in the understanding of the landowning formation that, following Marx’s paradigm, I used to associate with feudalism. However, I did not see the need to substantially correct the concept after analysing the critique of the previous book.

So, the following sequential application of cost regulators paired with the material metamorphoses of money gives us the following classification of economic¹⁹ formations²⁰:

Primitive-communal → (emergence of money) → slave-owning → (wages) → landowning (wider than “feudalism”) → (rent) → classical (gold) capitalism.

So far, we’ve singled out only the first four formations. Let’s put in a disclaimer that any schematic depiction of our civilisation’s development should not be initially thought of as a certain set of building blocks laid in a straight line and this study is no exception. Our brief enumeration of the main stages of economic development does not mean, for example, that there were no wages and salaries in the slave-owning epoch, or that slavery did not exist in the primitive-communal system. We’ll make this clearer later.

To begin with, we’ll note that formations differ more from each other than the planets of the solar system, though we certainly do not draw any parallels between formations and planets. One outstanding formation (say, Jupiter) is the landowning one. This stems from the non-reproducibility of land that has been influencing the economy all throughout economic history. We have already discussed that and we’ll talk more about it in the main text. However, some questions can already be answered by looking at the following chart where we picture the landowning formation in the relatively modest way in which it takes place in the historical sequence of formations:

You may have noticed that the beginning of the landowning formation rectangle is painted in the colour of slave ownership but the remainder has the “capitalism” colour, where the abolishment of personal dependency of peasants together with the final liberation of wages made working hands available for the development of capitalism (and also facilitated the purchase and sale of land). Still, the outsized economic (and legal) influence of major landowners (aristocracy, landlords, etc.) does not allow us to detect the beginning of capitalism as a predominant formation. Let’s emphasise that the actual event was the liberation of wages as a result of slavery abandonment, and not the transition to the landowning formation because of this liberation as one might think. The spread of wage labour practices was quite slow. In the “village”, it took longer as the private ownership of land by landlords was accompanied by a lack of personal freedom (in fact, enslavement) of peasants. The latter did not have an opportunity to earn additional income, given the dominance of agriculture in the economy. In the “city”, the transition was slow due to the insufficient development of natural sciences. Accordingly, the industry, which would require a rapid concentration of workers, was also undeveloped and did not adequately stimulate the emancipation of peasants.

Of course, history is not limited to these four formations and right about that time there were two other independent formations emerging:

→ (paper money) → paper capitalism;

→ (paper money; abandonment of the final cost regulator) → socialism.

This feeling of parallel development, in addition to historical simultaneity, is associated with the rejection of the gold standard and a complete transition to paper money. However, this parallel is quirky; imagine two “sworn brothers” each limping on different legs. The footnote attached to this statement²¹ clarifies the remark about the “curved mirror” parallelism of these two formations but not their essence.

The transfer to the seventh economic formation that we provisionally call the PCM²² requires the third and fourth basic cost regulators, interest rate and cross-prices, to be entirely market driven. Mere numbers will become the dominant form of money. While the last money metamorphosis has a pronounced evolutionary character, and the process has already started, the transition to full market functionality of interest rates (Chapters 1 and 2) and cross-prices (Chapter 3) will require radical, revolutionary changes.

In the theoretical toolset used for modelling the financial system of a PCM, there will be little specialised terminology and we will try to minimise the introduction of new terms. However, some habitual terms and processes will not receive so many habitual definitions. A system of definitions used by one or another theoretical economist largely reflects their historical localisation. Often, they are tied to a particular formation and inadvertently lose precision once that formation changes. All our basic definitions are tied to a PCM. In my mind, only by having this tie to the seventh formation, where all basic economic laws will reach their apogee after many centuries of maturing, can we reach the desired accuracy of definitions and terminology.

Definitions that work at all times are infrequent. Such is the definition of price, which is a fundamental definition in economic science for me. Having noted its pivotal character, we won’t talk much about it but we’ll encounter direct references to the definition of price when we construct money issuance under the new financial system.

In general, the proposed theoretical construct shares certain common features with all other known theories but differs from them in several principal moments. Despite my adherence to the principles of defining formations pioneered by Marx, I am a liberal economist (advocating a self-regulating market economy). As for a view from the outside, I guess those who read my work tend to classify it as a variation of neoclassical theory. With all due respect for these views, it may or may not be true.

Briefly deviating from the theoretical identification of this study, I would note that neoclassical theory is not really a “theory” at all. Unlike well-known theories of Karl Marx and John M. Keynes, which despite all their gaffes were marked not only by their integrity but also by cutting windows into the real economic world at the level of describing the principles behind entire formations, neoclassical theory appears to be more of a cosy virtual warehouse strictly intended for internal use. Once the place of this warehouse was occupied by the initial Theory (by Adam Smith describing “classical” – or in our parlance, gold – capitalism), the assumptions of it were gradually clarified and added. The neoclassical theory is convenient to teach students and gain recognition by the scientific community. One can “dig” into it for needed parts among the wrecked mechanisms of yore and notions about economic fundamentals of variable credibility. However, due to its fragmented nature, the neoclassical theory by itself cannot offer anything to “outsiders”.

Classification of this study will be further complicated, as we have already stated, by the difference between some PCM-specific definitions and those tied to the existing formation. The reader’s perception can be further confused by a combination of seemingly incompatible things. Many people who lived in the 20th century have bits and pieces of the contrast between socialism and capitalism etched in their minds. Our new financial system will be rigorous and laconic, earning a solid second place after socialism from that point of view. As for market self-regulation, it will achieve previously impossible heights in the new formation.

If someone thought that the author, with all his love for the market economy, was just sitting and thinking while constructing his new system, “And here we’ll go against our own convictions by adding a pinch of state regulation in the name of higher goals …”, this is definitely not the case. The entire proposed PCM model is built on the foundation of price definition and the visible (easy to formalise) portion of the “invisible hand of the market”, i.e. cost regulators²³ (with our attention focused on the four basic ones). The latter are based on the four defined basic types of property: commodities (goods), people, land, and money. It is impossible to knock down our model without denying the words highlighted in bold type in this paragraph – there is room for unlimited additions and clarifications, but the model will stand, immune to crucial changes. I hope that upon a closer look (and with a degree of forgiveness for the fact that I skipped a specialised education inside academic institutions causing the structure of this work to not be perfectly balanced) you will notice how the methodological toolset covers and ties together all the important parts of the economic system.

For our designed model of a self-regulating economy (the PCM model), we use the names “rigorous classical economy” or simply “classical economy”, which in particular allows us to set it apart from any neoclassical models and at the same time shows its ties to the theory developed by Adam Smith (even though this puts it somewhat closer to the neoclassical theory). That being said, under a “classical economy” we assume in this book a competitive market of managing owners that is self-regulated to the greatest extent possible and not a detailed following of the classical theory founded by Smith (see “classical economy” in the Glossary). Simply put, a classical economy is the economy itself and not the process of studying it. Nevertheless, I think that the principles describing how this economy is organised can be distinguished only by using a certain, more modern methodology that is different from the one used by Adam Smith²⁴ over two centuries ago.

I am using the non-rigorous expression “laws of classical economy” when talking about the basic (theoretical) relationships inside the practical economy, of which a classical economy is the most developed form. Since this book is a sort of presentation of the classical economic model, I have chosen this form for the brief naming of these laws. I also believe that in an economy (any national economy of any formation) there are and there will be certain uniform governing laws (or some bent versions of the laws stemming from applying them ahead of time, by mistake or not to a proper extent). I am not sure that it can be proven flawlessly, given the unpredictable nature of human behaviour and some mentality differences between nations, but I have yet to see any direct indications of a flaw in this statement. This uniformity of economic laws is best seen from “above” (the chain of formations) and “below” (fundamental principles of Homo sapiens’ behaviour which will be described further in our “Psychology and rationality …” thesis). As for the “middle” part, I could not commit myself to a detailed review of all formations, to say nothing about all national economies, but as you will see, some particular features of paper capitalism are easier to explain from the viewpoint of the PCM.

Let me finish the Introduction by pointing out a few key moments of this study in comparison with a summary of key milestones in the development of theoretical economics since the time of Adam Smith. Our comparison is not strict and its sole purpose is to facilitate a mutual understanding with the reader.

The fathers of classical economics, who arranged scattered observations of earlier economists into a system and thus founded economics as a science, put an important emphasis on the producer costs and microeconomy in general, coining a fundamental hypothesis about the creation of “value” that ostensibly takes place inside the microeconomy.

Marx was one of the most consistent followers of detailed microeconomic research in the middle of the 19th century. He offered further dissection of “value”, supposedly formed by actual production costs (hired labour expenses), against the background of the carefully arranged “iconostasis” which classified the means of production. If I managed to offend the reader by using the term “iconostasis” here, I can easily bring my apologies to the memory of the great German theorist. Let me clarify that it stems not from a lack of my respect to Marx, but from what happened later: the studying of the works of only one, undoubtedly genius, economist by an entire national cohort of economists for decades makes one think of some religious associations. Generally, a certain theoretical narrative about the means of production is useful in teaching future economists and not only to make them familiar with the basics of accounting. However, it is much less useful in trying to find the theoretical essence and can lead to the inference of some erroneous relationship.

Marx’s theory played a substantial role in the history of both theoretical economics and human civilisation, but the development of mainstream economics took another direction. Emphasis on the priority of costs caused a natural protest due to the simple reason that besides producers there are also consumers and besides supply there is also demand. This brought to life the utility theory, which made an attempt to measure, and even sort out, buyers’ motives in deals.

The most unpleasant outcome of microeconomy studies in the 19th century was not even “value”; something that is not taken seriously by modern economic scientists. Rather, these studies gave birth to “marginal quantities”, with the most recognisable among them being “marginal cost” and “marginal utility”. Alfred Marshall used his “equilibrium price” to tie these two into a well-known trio that struck a temporary truce between the adherents of the supply theory and the demand theory in their versions at the time. This construct is remarkable for the fact that all three of its components are contrived, as none of them can be distinguished in the real economy.²⁵ Subsequently, these components followed different life paths. Many have doubted the validity of marginal utility from the outset (for no obvious units of measure) and the equilibrium price is used primarily by analytics (for instance, for technical analysis of the stock market), but the marginal cost, unfortunately, took a sizeable foothold in theoretical studies. They are used to create mathematical models and entire theories, like Ronald Coase’s transaction costs theory. The latter by themselves cast serious doubts about their ability to reflect real economic processes. Later in this book we’ll devote some time to transaction and marginal costs to better understand why we do not use them.

In the 20th century, theoretical economists, with Keynes being the most prominent of them, started prioritising studying “aggregate demand”²⁶ and here the important part was shifting twice compared to the traditional classical school: from supply to demand and from microeconomy to macroeconomy (to the level of national economy). This accent is present in modern day theories as well, given that the current model of the world economy (paper capitalism) makes it very natural at first glance. However, we’ll see later that Keynes’s theory may trigger some fundamental questions.

As for the costs proper, microeconomic costs are still in the limelight to a large extent, thanks to the influence of neoclassical theory, which traditionally (albeit with some modifications after Keynes’s theory emerged) pays attention to the production of goods as a crucial factor driving the supply. The notorious marginal cost is also playing a role here.

Now, it is very easy to explain the key points of this study: instead of following the diagonal line of “microeconomic costs – macroeconomic demand”, I put emphasis on a different one: “microeconomic demand – macroeconomic costs”. I admit to finding this out for myself towards the end of working on this book,²⁷ i.e. 14 years after I had traded my career as an entrepreneur to that of a theoretical economist, when I faced the problem of visualising my theoretical views.

So, the first moment in our study of the market economy is the priority of sales over production and, correspondingly, the priority of demand over supply inside a firm (inside a microeconomy). This moment should be easier to understand by post-Soviet economists, as we have witnessed a radical shift in priority once the economy shifted from production-dominated socialism to a market economy. Despite the relatively modest place of these discussions in the text, understanding this simple moment will guard us from trivial mistakes (for instance, a modern manager ostensibly makes decisions based on some “marginal cost”) and will make us feel more confident while thinking about processes taking place in real firms.

The second moment has a cardinal theoretical meaning: at the level of the national economy, costs are fundamentally more important than demand. This is impossible to observe at the micro level and cannot always be seen while analysing a single national economy under a single formation. There are various formations and diverse national economies. If we are talking about present times, the macroeconomic priority of costs over demand will be the last thing on your mind when discussing the modern US economy. Indeed, Keynes’s theory, despite its questionable nature, is still applicable to the American economy.

The macroeconomic priority of costs is easier to see when analysing the world economy as a whole. Worldwide economic crises are especially illustrative, as attempts to explain the root causes and work out anti-crisis measures without taking this priority into account will cause inevitable mistakes. As for finding out the essence of formation changes, including ideas about what the next formation will look like, it is impossible without taking this priority of costs. Note that we are talking about the theoretical priority of costs in the national economy as a whole²⁸ and not only about cost priority over demand that is matched with costs to provide a better visual link for theoretical thought development. Earlier in this Introduction, we have already seen the categories succinctly reflecting this priority: basic cost regulators. This priority is best illustrated while discussing the principles of formation changes and informally we focus on them when calling these regulators a visible part of the “invisible hand of the market”.

The structure of this study is a little unfamiliar. At the beginning of each of the three chapters (beginning at the second part of Chapter 2), we put a brief description of yet another component of the PCM financial system, followed by clarifications, comparisons and justifications. We begin with the payment system.