Market, Economy and Cycles, Part 1

6 min read

In this sharing, we look to better understand the essence of a free-market economy from a more fundamental viewpoint of the market interactions. We also look to understand the cyclic patterns of the economy from a perspective different from Western Economics.

This is the first part of our firm’s internal sharing during a recent hindsight analysis of the market. Before discussing specific issues, let’s first discuss the correct method to study things.

Generally, we first analyze the problem, find out the main contradictions, and then remove the non-critical factors as much as possible to restore things to the most generalized state.

Starting from the study of the most basic things, gradually moving from simple to complex, from concrete to abstract, to continuously improve our understanding of things.

During the study of things, finding new laws does not necessarily mean that we should abandon the laws we have been using previously. In fact, the new laws are simply a further understanding of old laws.

The old laws are our approximations of things in our previous state of understanding. This approximation is sometimes still useful even if we have a new understanding. For example, we now have quantum mechanics and relativity theory, but the study of the motion of cars does not require relativity nor quantum mechanics. Simple Newtonian mechanics can be used because it is sufficient in such a simple case.

  1. Market Economy

Today’s topic focus is on economic cycles. In order to study it, we need to first understand the economy itself.

“Economy” as we are talking about now is basically an economic model based on the market economy. Thus, we must first study the market economy. There are many kinds of market economy, such as the monopoly market, free-market economy, and China’s unique socialist market economy.

These market economies have their own characteristics, but essentially, it stems from free exchange. To study the market economy, we must study the simplest form of free exchange.


market economy

What is the simplest form of free exchange? It is the original free market.

Simply put, the two parties started of producing for their own consumption. However, because the parties’ productions are different, yet can be used by both sides, they can thus exchange their excessive goods.

The exchange between the parties does not require any currency. In fact, we might observe similar barter trade in rural areas. Both parties may just use eggs as a measure to buy what they need.

Social Division of Labor

To study the market economy, we have to track the origin of markets.

Markets originated from the evolution of human production model. The reason why humans are the wisest of all beings, independent with high self-initiative lies in the fact that humans are able to actively produce more than they need. Although, this is what every living creature is capable of, without which there will be no advancement, but only humans are consciously producing more than needed.

Even earlier than primitive societies, humans were probably fighting alone. With everyone only producing what he or she needs, they could hardly survive because the natural environment was very harsh.

This creates a problem: One can never ensure his/her own survival alone.

market economy

Therefore, the primitive people formed small social groups to improve their ability to withstand risks as a whole. This resulted in the formation of the original tribe, which created a general social cooperative relationship. Since then, human beings had social characteristics and became social people.

Thereafter, humans found that general cooperation was not efficient. If everyone could specialize and concentrate only on what he/she is good at, the overall efficiency will improve greatly. This resulted in the formation of the social division of labor: each person only performs the part that he/she is good at, and then everyone assembles the product together. Such cooperation will optimize the efficiency in producing the final product.

market economy
Division of Labour, CartoonStock

However, the social division of labor led to new problems: everybody’s products must be exchanged with others in order to meet everyone’s needs. This slowly made exchange the main purpose or even the sole purpose of production.

At this time, human beings had entered the commodity-based society, characterized by exchanging being the sole goal of social production.

Birth of Currency

Since the main purpose of production in a commodity-based society is to exchange, people have come up with a universal equivalent to improve exchange efficiency. Universal equivalent is a commodity that can be directly used to exchange for any other commodity.

We call a commodity that can be used to exchange for any commodity, a currency. Seashells used to be a form of currency because they were very rare for people in the inland areas.

market economy
The Invention of Money, Quora

After the period of the Seashell, humans used a variety of different currencies before fixing it eventually as gold and silver. This is because gold and silver have stable chemical properties, and the cost of refining basically remains unchanged as time goes by.

Throughout history, the cost of producing gold remained almost unchanged. Until now, gold mines in Europe and America produce at an estimated cost of 1300 USD/ ounce. All of these mines were, in fact, producing nearly at a net loss before the gold surged in July.

After the emergence of currency, the production model changed further. The original purpose of production shifted from exchanging to obtaining currency. In this model, production is converted into money through sales, and then new production materials are purchased and used for production again. Producers make profits through this process.

From this perspective, the starting point of capitalism and Western economies is the same. The initial discussion was about a balanced and effective free market under perfect competition: perfect competition, market effectiveness, and the free market. The market by itself cannot be said to be good or bad.

  1. Capitalism

Since then, we have entered the capitalist society, which obtaining capital appreciation is the core of all production relations.

Capital Cycle

In the capitalist market, capital has its own fixed mode of circulation:

Step 1: Purchase production materials and labor-force commodities with capital;

Step 2: Sales of products produced to earn profits. This step is called a “dangerous jump”, in a sense that capitalists must bear the risk of not being able to sell the products during the production process;

Step 3: Capitalists sell to gain capital, and continuously iterate this process to add value.

Banks: The Core of the Society

The formation of banks is to meet the needs of financial lending. It is the center of cashier and balance settlements. All the money in the factory needs to be circulated through the bank, which naturally makes banks become the capital “tap”. Hence, banks have the right to choose the flow of capital.

Banks as “Taps”, Crunchbase News

There are risks in capitalism’s production model, especially when a single enterprise is facing the entire market. It faces risks such as the “dangerous jump” and the risks in all aspects of the supply chain. On the other hand, banks are different because they mainly hold cash (to simplify the discussion, we do not distinguish between currency and credit currency), which minimizes risks. Therefore, banks can provide capital support for other enterprises. As long as social production exists, capital will be able to earn interests.

Since banks are at the center of cashier and balance settlement, as well as the inherent risks in the capitalist production model, banks with interest-earning capitals have higher risk tolerance. This has formed the basis of controlling all production activities. At the core of modern consortiums are the banks. All economic activities begin from the bank and end at the bank, this is the financial system of modern society.

With banks being the core of the whole society, it assumes responsibilities to society.

Emergence of the Crisis

If we look back at markets, we will find that the entire production process is a cycle:

market economy

In this cycle, the products must be sold and the payments must be received before the producer can have the capital to invest in the next round of production. Only in this way can the surplus value be converted into profit.

To better illustrate this, let’s assume that in a simple market, workers produce goods that help the capitalist to earn 100 yuan of profits. However, the capitalist only pays workers 30 yuan, and the remaining 70 yuan will go to the capitalists.

This creates a problem: goods are consumed by all groups in the society, hence, workers need to buy them. If workers do not have enough money to purchase these goods, the aggregate output of the whole society will be greater than the aggregate income that can be used for consumption.

Yet, since the capitalist’s money is mostly used to gain value, it will not be fully spent on consumption.

market economy
Capitalism, Foundation for Economic Education

Therefore, there will always be some goods that are unable to be converted into profits. This results in the capitalists being unable to recover capital for next round of production. According to the general production efficiency and capitalist profit margin, the average growth rate of all industries is about 20%.

Following this scenario, after deducting the costs, the unsold goods in one year is 10%. Cumulating the unsold goods for 10 years would bring it close to 100%, which means that almost all goods are unable to be sold.

That is why the economic crisis happens basically once every decade from the mid-19th century to the 1930s.

market economy

This is a process of dynamic accumulation. Once accumulated to a certain extent, the economic crisis will be exposed. Before the crisis, everyone would think that the products will be sold. After the economic crisis, there is a need to study it and come up with solutions, which would be handed over mainly to the economists.

  1. Measures to Tackle Economic Crisis

Historically, economists proposed the following measures:

market economy
Smith; Marx; Schumpeter; Keynes, Prospect Magazine

Neoclassical Economics

They once thought that everything that happens in the market economy is right. Joseph Schumpeter once declared that “depressions cannot be simply regarded as something bad”, but “a manifestation of something that must be done”. They believe that the market can be restored to an effective state through spontaneous adjustments.

They do not acknowledge the existence of economic crisis and believe that the economic “crisis” can be healed naturally.


Keynes advocated the use of positive government intervention – to print more money and to invest heavily in public projects if necessary, in order to deal with the unemployment problem during the recession. Simply put, the government expands credit and releases liquidity, which is disguised as inflation in a bid to alleviate the economic crisis.

Marxian Economics

Return the capitalists’ surplus to society, thus allowing everyone to consume together. Once the production’s surplus value in a certain area is found to be excessive, the surplus will be invested in a new direction.

In fact, since 1940, all countries have adopted the Keynesian approach to resist economic crisis.

market economy
Keynesian, GreekShares

When the economic cycle comes, the government expands credit to release liquidity, then builds large-scale infrastructure projects, absorbing debt disguised through inflation.

Finn Zhang Finn Zhang holds a Master degree in Physics (Ph.d ABD). He has done research on particle physics, statistical physics, mathematical physics, and computational physics. He has worked on the modeling of physics and social science problems using mathematics and statistics for many years in the industry. Further, he has applied a nonlinear dynamics method and made progress in marketing analysis and price prediction. Currently, his main interests are in heterodox financial model building and data-driven financial modeling.

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