A Blog of the Global Justice Movement

Friday, January 16, 2009

In Keynes We Trust

Over the past week, participants in the Kelso Binary Economics Discussion Forum (which you can join by going to the CESJ web site, www.cesj.org, and following instructions) have been having a little fun with the complaint circulating around the internet that the new dollar coin allegedly omitted the traditional motto, "In God We Trust." It's on the edge, where, since the advent of coin stamping machinery (as opposed to hand-hammering), it's been possible to put lettering if a coin is thick enough. Naturally, some people more concerned with form instead of substance declared that this was yet another move by the anti-American atheistic communist secular humanist et ceteras to destroy the country.

If only people got this worked up over the much more egregious matter of the misuse of the Federal Reserve System resulting from the worship of the false god Keynes. Thanks to St. Paul, it's easy to get religiously-motivated people worked up about love of money, worship of money, infatuation with money, etc., etc., etc., but not about misunderstanding of money, and its related institutions, credit and banking. Perhaps people are afraid to understand money, because (as the old saw goes) "to know me is to love me," and they want to avoid loving money at all cost . . . if you'll pardon the expression.

In any event, St. Paul didn't say anything (as far as I know) about blindly following people who screw up the financial and economic system to fit their pet theories, even when the facts prove them absolutely wrong. This is what Dr. Harold Moulton did with Keynes in 1935, in Moulton's brief monograph, The Formation of Capital, perhaps the best proof of the validity and soundness of the "Real Bills" doctrine.

Briefly, the "Real Bills" doctrine is that banks can create money as needed without inflation, if money creation is limited to financing self-liquidating capital projects. The doctrine is based on "Say's Law of Markets" (rejected by Keynes) which states that "production = income." That being the case, anything that is produced, or is reasonably expected to generate production, can be "monetized," and there will be no inflation because the supply of money and the supply of goods and services rises and falls in tandem. This is because supply (production) generates its own demand (income), and demand (income) generates its own supply (production).

Keynes' assumption that demand must be reduced in order to save is negated by the Real Bills doctrine. Under the Real Bills doctrine you don't need the rich (who produce far more than they can consume and are thus forced to save and reinvest their "demand" in forming additional new capital), because the banking system can create the necessary financing. By cutting demand to finance capital formation, you reduce consumption, and thus goods pile up unsold, companies cut production and lay off workers, and consumption falls even faster. To counter this, Keynes claimed that the State had to create money in order to increase demand. Thus you have the "traditional" Keynesian tradeoff between inflation and employment. If you want people to have jobs, you need to inflate the currency, but if you want low inflation, you have to put up with unemployment. None of this, of course, explains the centuries, millennia even, when you had full employment and low or no inflation.

Keynes' paradox results from Keynes disconnecting money (effective demand) from production (supply). When supply and demand is in equilibrium, there is no inflation because there is as much demand as there is supply, and as much supply as there is demand. By distorting one side of the equation by printing up money, however, Keynes locked the world's economies into a hopeless countercyclical spiral of inflation and unemployment.

The key to understanding this is that when the State creates money without backing (or, more accurately, backs it with a promise to pay out of future tax revenues, and thus creates a debt-backed currency), it doesn't really create demand. On the contrary, through the "hidden tax" of inflation, the State by printing money (or creating demand deposits) transfers or redistributes existing demand by making each unit of currency worth less in proportion to the amount of unbacked or debt-backed new money. That is, as any monetary economist will tell you, by doubling the number of units of currency in circulation without increasing the goods and services available for sale, you reduce the value of the existing units of currency by half, the value being transferred to recipients of the State's largess. The State produces nothing by its nature, not even demand. It simply shifts around what already exists by creating additional claims on existing wealth.

This is why Keynes rejected Say's Law and the Real Bills doctrine based on Say's Law. Say's Law makes Keynes look like an idiot, so he had to nip in there first and claim that Say's Law and the Real Bills doctrine were "discredited," as you will read, e.g., in the Wikipedia, but without explaining why.

The fact is, however, that Say's Law and the Real Bills doctrine don't work — at least not in a modern industrial economy in which human labor is being displaced as the predominant factor of production. Say assumed that there were no barriers to people acquiring capital when they could not produce by means of their labor. There are barriers, however, and those barriers are significant. Even in a Keynesian economy existing accumulations aren't used for investment directly, a fact Keynes appeared to be completely unaware of. Keynes himself maintained that "savings = investment," but failed to realize the implications of what he claimed was an iron law. If savings = investment, then where do the savings come from for new investment? Everything saved is already invested!

The fact is that existing savings are not used directly for investment. Existing savings are used for collateral for loans for new investment. As another old saw goes, you need money to make money. It's not that you need money to invest directly, you need money to ensure that whoever lends you money so that you can invest will be repaid.

This is the barrier that neither Jean-Baptiste Say nor Harold Moulton recognized. Say's Law and the Real Bills doctrine will not work if all (or nearly all) income generated by both labor and capital isn't spent on consumption. Both require that ordinary people own a share of the means of production in order to gain income when they can no longer sell their labor for enough to provide an adequate and secure labor income. The problem is that ordinary people don't have savings — collateral — to ensure that they will be able to repay someone who lends them money to purchase capital, should the capital by some chance not pay for itself.

Lack of collateral is the barrier that Louis Kelso and Mortimer Adler saw as preventing people from participating in the economy as sellers of labor, owners of capital, consumers, and producers. Without the ability to become a capital owner instead of being limited to an owner of labor, ordinary people are cut off from the immense stream of income (demand) generated by capital, and thus can't spend it.

Keynes thought you could make up this lack by "creating" new demand (actually redistributing existing demand) by printing money, thereby disconnecting demand from supply, and then trying to force them back together. In essence, Keynes took away the glues, screws, and nails that held the economic system together, and tried to fix it by pounding things back in place with a monetary and fiscal sledge hammer. It's no wonder that what we end up with is a mess of splintered wreckage.

To put things back together, we need a Capital Homesteading program that will remove the barriers to full participation in the economic common good, and replace the Keynesian sledge hammer with something a little more subtle . . . like the economics of reality and common sense.

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