We realize that this discussion of where money comes from to finance new capital investment is starting to sound like an extremely involved episode of The History Detectives. It is, however, necessary to cover this ground. People's ideas of money, credit, and interest have been so confused by the diligence of Lord Keynes and his disciples, that countering the economic policies inspired by the Great Defunct Economist requires a great deal of explanation.
The standard Keynesian line is that private individuals accumulate savings, then invest them to finance capital formation. This is absolute, as any reader of Keynes' General Theory (1936) can tell you.
When you take an economics course in college, however, you are taught that the government either taxes people or prints money (taxing people through inflation), spends the money to create jobs and increase effective demand, and saving by the rich following the increase in effective demand provides the financing for capital formation. In Keynesian economics, of course, it is necessary to save in order to invest, but possible to invest without first saving by increasing government expenditures and thereby increasing the amount of financial capital available. That is, you can spend what you don't have, and invest without having produced anything to save.
If you understand the preceding paragraph, you, too, can get a doctorate in Keynesian economics and run any economy in the world into the ground.
The belief that you cannot create money to finance capital formation is the pillar of iron at the heart of Keynesian economics, an absolute on which the whole of the Keynesian system is built. Unfortunately, another adamantine pillar shores up the Keynesian system — and contradicts the first pillar, to say nothing of being some of the purest usury the world has ever seen. That is, the State can create money backed by nothing but more government debt, even beyond its ability to tax the citizens. This will increase effective demand ("Keynesspeak" for consumer spending, i.e., non-productive money creation or usury), thereby creating jobs and stimulating more effective demand. This is, in effect, the belief that you can spend your way out of debt.
Mark Gongloff's "Ahead of the Tape" column in today's Wall Street Journal, "On Borrowed Time: Consumer-Led Recovery" (06/09/09, p. C-1) suggests otherwise. Mr. Gongloff reports that, as of the end of 2008, accumulated consumer debt had reached $13.8 trillion, at the same time that 2008 GDP was $14.3 trillion. If all consumer debt had been paid off in 2008, people would have had a per capita 3.5 cents to spend for every dollar earned. Add in the possibly low estimate of outstanding U.S. government debt of $11.3 trillion, and in 2008 people had a per capita potential negative 75.6 cents to spend for every dollar earned . . . if every cent of GDP had been used to pay down debt.
The federal government now proposes to add another $288 billion to the mountain of debt and spur consumer lending to stimulate the economy, leaving approximately negative 77.6 cents of every dollar earned to spend on anything on a per capita basis. Thus, if people stop consuming (i.e., eating, drinking, living . . . ), there will be negative $11.1 trillion to invest in replacing worn out capital and growing the economy, thereby creating jobs.
The conclusion is obvious to anyone who has not been blinded by Keynesian rhetoric and predictions based on unfounded and illogical "hope" that the recession is on its way out: Recovery is impossible in the Keynesian framework. The savings required to invest in replacement and new capital formation simply do not exist, and do not exist to the tune of $25.4 trillion, more than ten times the annual new capital formation that takes place in the U.S. economy.
There is, however, paradoxically a great deal of hope in the current situation. The situation described above is absolutely impossible, as even people suffering from severe Keynesian financial delusions are beginning to realize. Once we realize that Keynes' iron dictum that savings must necessarily precede investment is necessarily wrong, the whole Keynesian house of cards tumbles down.
Obviously there has been new capital formation going on. Just as obviously there are no savings in the system to finance any capital formation, new or replacement. The money to finance capital formation couldn't possibly have come out of savings as Keynes insisted it must. The essential contradiction inherent in the Keynesian system is that it relies absolutely on something that Keynes declared was impossible: financing capital formation without existing accumulations of savings. How this is possible we will begin to examine in the next posting in this series.