Wednesday, January 7, 2009

Keynes on "The Future"

Earlier today we received the following comment from a reader in Canada in response to yesterday's posting of the letter to the Wall Street Journal on the "Paradox of Thrift":
Well put Michael. However, I think Keynes' work was not really about economics, as is generally believed, but was instead about helping form a world power structure. Keynes did come clean on this in his last essay, "The Future," with his infamous, easily verified, statement.

"We must pretend to ourselves and to every one that fair is foul and foul is fair; for foul is useful and fair is not. Avarice and usury and precaution must be our gods for a little longer still."

The obsolete over-centralization favoured by Keynes and crowd would grow from encouraging saving by the public, even though Keynes was well aware this would harm the economy. The more money is removed from the economy by the people, the more it is necessary for government to step in and to take over more of the economy. This was the goal. In saying "we must pretend to ourselves and to every one that fair is foul and foul is fair; for foul is useful and fair is not", Keynes is admitting the effectiveness, and his use of, the big lie technique. The Achilles heel of this MO is free communication amongst the public in general.
This, of course, inspired additional commentary on Keynesian economics.

It's worse than the commentator believes. In his General Theory (1936), VI.24.ii, Keynes states briefly (for him) that it is necessary for the advancement of society that the "rentier" (a small investor who lives off the income generated from the investments and does not reinvest) must be eliminated from the economy. Rather callously (and inaccurately) Keynes speaks of the "euthanasia of the rentier." He doesn't mean actual "mercy killing," but gradually forcing people to divest themselves of assets so that they rely completely on wages and welfare.

Nor are the rich safe from Keynes. In the section following, VI.24.iii, he makes his case for total State control of the economy. He declares, "It is not the ownership of the instruments of production which it is important for the State to assume. If the State is able to determine the aggregate amount of resources devoted to augmenting the instruments and the basic rate of reward to those who own them, it will have accomplished all that is necessary."

In English, that translates as, "It is not necessary for the State to take legal title to anything to effectively 'own' it. If the State is able to determine how much someone may 'own,' what they may 'own,' and how much the 'owner' is permitted to derive as the fruits of his or her 'ownership,' it will have accomplished all that is necessary." Control of the fruits of ownership is the determinant in the question as to who really owns something. How much of what someone may possess is a prudential decision society makes that, as long as it doesn't undermine or abrogate the underlying natural right to be an owner, is a necessary and healthy thing for the social order. Mandating how much someone can derive from his or her assets in the form of income or other control, however, is the essence of private property, and interference with that is effectively socialism. Of course Keynes said that the State "will have accomplished all that is necessary" if it controlled capital without taking actual title. It wouldn't need to take nominal title, for it would already own in fact.

Keynes also made the same mistake that many people do as a result of rejecting the "Real Bills" doctrine. That is, Keynes assumed that only currency and demand deposits constitute "money." On the contrary! One of the problems that the Federal Reserve has in trying to keep track of the monetary system is defining what, exactly, money is. "M1" is easy: currency and demand deposits. If that were all money was, however, we wouldn't need all the other Ms.

The fact is that the bulk of the money supply is made up of transfers between private individuals, companies, and countries that may or may not bring a bank or the State into it. These entities actually create money when they engage in transactions among themselves by exchanging IOUs, promissory notes, bills of lading, commercial paper, and so on. If the parties trust each other, they don't need a bank or a State to regulate the transaction or ensure that each party keeps its word. This is so common that finance experts even have a special term for it: "disintermediation," a ten dollar word for a multi-trillion dollar process. The transactions are denominated in the local currency, of course, but an actual check drawn on a bank, or a unit of currency may never change hands. This was how many stores in rural areas operated in the U.S. up through the mid-20th century. The storekeeper would keep a ledger recording all purchases by a customer, and when the customer brought in goods, the storekeeper would credit his or her account. Before the coinage reform of 1873 and the National Bank Act of 1864, in fact, stores couldn't have operated in any other way, for there wasn't enough currency in circulation to provide for the transactions demand outside large cities, and often enough not even there, accounting for the large number of merchant's tokens and company scrip that circulated to the delight of modern collectors and frustration of contemporary merchants and customers.

I think this might answer a concern you raised in an earlier posting [in the Kelso Binary Economics Discussion Group]. I think you said something to the effect that if all new money were issued by a bank to finance a capital project, and the bank received back more than it created, the local economy would be drained of money (or words to that effect, it's early in the morning, and my memory is going). This makes sense — if "money" includes only currency and bank demand deposits, the economy is "static" (i.e., the process of new money creation is not ongoing, so that new money isn't always coming in to the economy as old money is retired as loans are repaid), and the money does not circulate beyond the original borrower.

This last is the most counter-intuitive. Back in the 17th century a man named Sir William Petty asked if a country had (in his example) £8 million in transactions in a year (what we would call GDP, I think), did the country need to mint £8 million in gold and silver coin, or emit treasury bills of £8 million? He answered his own question by reasoning that, if each coin were spent an average of 4 times in a year, the country would only need £2 million worth of currency, for each coin would do the work of four. This was an early, perhaps the first formulation of something that we call "the velocity of money." A bank or State doesn't need to create £8 million in currency or demand deposits to carry out £8 million in transactions. It only needs to create as much as will be used at any one time, for each unit of currency can be reused, effectively multiplying the money supply. Fortunately, the only way this is inflationary is if people lose confidence in the currency and increase the velocity of money by spending it as fast as they get it. Keynesians believe that the velocity of money is fixed at five, or so I was told in college, meaning that, on the average, each unit of currency is spent five times in a year.

That's one part of the answer as to why a region wouldn't be drained of money if a bank takes back more than it created. Money is only a marker for a promise, a convenient vehicle that passes from hand to hand as promises are made and kept. When money takes the form of currency, it can be reused over and over again, each time in the making and keeping of a new promise, until it finds its way back to the issuer in payment of the original debt, and is canceled.

For example, suppose a bank prints $100 in exchange for a lien on a productive asset. The borrower repays $110, the $10 being the service fee the bank charges for generalizing the borrower's purchasing power and changing it into a form that everyone in the community will accept. The bank cancels $100, and pays out $10 as wages, other operating expenses, or dividends. The $10 reenters circulation, being used by the recipients for their expenses, and so on in turn, until it finds its way back to its original issuer, and is canceled. In the meantime, of course, new money has been created to form new capital, so that as the old money leaves, new money enters the economy.

Again, however, that's only part of the answer. The other part is that, per Say's Law of Markets, production = income, and Say's realization (along with Adam Smith) that we don't really make purchases with "money," but with what we produce; that we cannot purchase anything unless we have produced something. I'm going to quote it wrong, but Say said it something like this: "For it is in reality with our own productions that we purchase the productions of others, and it is impossible to purchase anything unless we have first produced, whether by means of our labor, capitals, or lands."

Thus, whenever we produce, we generate income ("money") that we can use to purchase what others produce. We may be making widgets, and want to purchase gadgets, so we trade some of our widgets for the gadgets of someone else. We may or may not use currency or demand deposits to facilitate the transaction (international trade, for example, while measured in terms of currency, rarely involves exchange of currency or demand deposits, but commodities and goods valued in terms of an agreed-upon unit of value), but "money" is created whenever we produce something, for we have created something that has value to others that can be traded for what others produce that has value to us.

The bottom line is that capital continues to produce long after it is paid for, thereby generating income ("creating money") for its owner. A bank is very useful in changing production into a form that is generally accepted in the community, but is not absolutely necessary ... if you don't mind the incredible circumlocutions and techniques involved in running a barter economy. The ancient Egyptians ran an extremely sophisticated economy on barter, but it required an incredible number of scribes to record virtually every transaction — there was no easily transferable means of conveying value between two individuals (i.e., currency). They always had to bring in a third party, who may or may not be honest, and keep a huge number of records. (One of the reasons why scribes were usually attached to a temple, so that the gods would keep them honest, and why the first actual banks were located in temples as well; some authorities believe that Jesus didn't drive the moneychangers from the Temple because they were moneychangers, providing a necessary service, but because they were doing it dishonestly by overcharging for the service they provided.)

Merchants and manufacturers can, of course, exchange bills of lading, commercial paper, and so on, among themselves without ever bringing a bank into the transaction, but it is much more convenient in many cases to "factor" inventory (sell or loan it to a financial institution) so that you get cash or a demand deposit right away instead of waiting for a customer to show up. The "cheese banks" of Parma have operated in this way for centuries. Bringing a bank into the picture makes things easier, and "transforms" the various financial instruments into "bankers' acceptances" with the bank's word guaranteeing the value instead of the original issuer. For this the banks legitimately charge a fee and, if necessary, a "risk premium."

Thus, the money supply is always far greater than what is created by banks or the State in the form of currency or demand deposits. As long as the State or banks don't start issuing debt backed money (i.e., money backed only by someone's promise to pay, and not a lien on an actual hard asset), there is no problem, and the only danger of inflation comes when there are actual shortages or increases in actual demand for something of which there's not enough of to satisfy the increased demand (whereupon a new producer is lured into the market to bid down the price). The only danger of deflation is if people are somehow restricted from changing their productions into a generally-accepted form that they can spend anywhere, e.g., the dairy farmer who can't raise a loan on his cheese or manufacturer who can't find someone to buy or give a loan secured by his or her inventory. We're seeing this now, where manufacturers' stocks are piling up because financial institutions won't loan money on inventories when consumers aren't buying. This is why the recent spate of bailouts are ultimately self-defeating: they don't change the system so that people can gain an adequate and secure income, they give money to people who can't loan it if they're ethical, and shouldn't loan it if they have half a brain in their heads.

Under the "Real Bills" doctrine, the idea that there cannot be enough money in circulation (the backbone of Keynesian "demand driven" economics and justification for the State running the printing presses) is utter nonsense, which may explain why Keynes rather pompously declared that the Real Bills doctrine was "discredited" — his system made no sense if he admitted its validity, and might even come across as somewhat insane.

No comments: