Monday, December 29, 2008

Even Keynesians Agree: Savings Equals Investment

We didn't get a chance to post this letter to the Wall Street Journal on the blog the day we sent it, but the situation hasn't changed any, and the points remain valid. We did cc. members of the Kelso Binary Economics Discussion Group, one of whom forwarded the letter to the President-elect's new website with the following note: "This is profoundly important and needs to be heard. It also needs to inform how we address the economic crisis we are confronted by." He then added the comment, "Let's hope someone is paying attention."

Messrs. Damian Paletta and David Enrich's article in today's Wall Street Journal poses a seemingly insoluble conundrum ("Banks Told: Lend More, Save More," WSJ, 12/26/08, C1). The only problem, however, lies in approaching the task from the inherently flawed perspective imposed by reliance on Keynesian economics. According to the world's most noted defunct economist, it is impossible to finance capital formation (investment) without first cutting consumption and saving. That is the only way (so Keynes believed) the "iron law" that savings = investment could be held sacrosanct.

Commercial banking, however, is premised on something called the "Real Bills" doctrine. Rejected by Keynes because it contradicted his most deeply held dogma, the Real Bills doctrine states in essence that if money is created through the extension of capital credit for financially feasible, self-liquidating investments, there will be no inflation or deflation. Further, there will always be exactly enough investment capital as is needed to finance sound capital projects that pay for themselves out of future profits. The savings = investment equation remains valid, for the only change is that, instead of first saving, then investing, the process becomes first investing, then saving, as the equation itself implies.

The Federal Reserve System, in common with virtually every other central bank in the world, was established firmly on the assumption that the Real Bills doctrine remains permanently valid. Creating money through the commercial banking system by discounting eligible commercial, industrial, and agricultural paper at the Federal Reserve and collateralizing the loans with capital credit insurance has the potential to provide as much financial capital as is required to finance sound capital projects. Using the central bank to extend credit for government expenditures, consumer spending, speculation, or vague "economic stimulus," however, is a recipe for the inflation that Keynes relied on to fuel his economic system and creates the illusion that real investment and production are unnecessary, or a distant second to Keynes' program of inflating demand artificially by manipulating monetary and fiscal policy.

Under the Real Bills doctrine, it is possible for the banks to do as a matter of course what in the Keynesian universe is impossible: increase both savings and investment at the same rate by adhering strictly to the law that even Keynes relied on: savings = investment. A means to achieve this end can be found in a proposal called "Capital Homesteading for Every Citizen," from the book with the same title. A study of the proposal by bankers and policymakers confused and bewildered by the economic crisis would be well worth the effort. It's time people stopped being the slaves of "some defunct economist" who got us into the present mess in the first place, and learned to rely on their own common sense.

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