To return once again to the subject of money, we realized in our last posting on the subject that it is not human labor that generates the bulk of production, but capital. The problem then becomes how people without ownership of the means of production — capital — can become owners without taking away anything from anybody else. Within the paradigm of the Currency School that declares that capital formation cannot be financed without using the accumulations of the wealthy, acquisition of an ownership stake by people without savings becomes impossible unless the wealthy voluntarily divest themselves of their presumably ill-gotten gains, or they are involuntarily divested by others. The former is unlikely, the latter is unjust.
The operation of the real bills doctrine would, of course, circumvent the presumed reliance on existing accumulations of savings, but the Currency School, on which virtually all modern schools of economics are based, rejects the real bills doctrine as a "swindle," "disastrous," or any other pejorative that comes to hand. Thus, despite the common sense embodied in the real bills doctrine, people trap themselves by the assumption that only existing accumulations of savings can be used to finance capital formation.
The key to understanding the real bills doctrine is to realize that "present value" includes today's value of a marketable good or service that does not yet exist, but for which a promise has been made to deliver once it is produced. That promise to deliver a marketable good or service, even though it relates to a good or service that has not yet been produced, has value. Consequently, a bill can be drawn on that promise, be backed by the real, present value of that promise, and redeemed once the marketable goods and services have been produced.
A good rule of thumb for purchasing capital, in fact, is based on an application of the real bills doctrine. An entrepreneur or investor is not really purchasing an investment as an existing thing, but as the present value of the future stream of income to be realized from the investment. Thus, if an investment is expected to yield nothing, it is hardly an investment, and has a present value of zero. If, however, an investment is expected to yield $1 million each year, then, obviously, the investment is estimated to be worth $1 million per year. If the purchase price of the investment is less than the value today of $1 million each year in the future, the investment is considered a "good buy." If, on the other hand, the purchase price of the investment is greater than the value today of $1 million each year, the investment is presumably not a "good buy."
Thus, the "present value" of a stream of income expected to be generated by an investment is real value, and — assuming that proper due diligence has been carried out by all parties to the transaction — a bill can be drawn, backed by that present value. That bill can be discounted, and money created using the bill as the backing of the money. It is not necessary to have accumulated savings in order to create money to finance the formation of that capital. The value of the investment itself can be used to "leverage" the purchase, for the asset is expected to generate its own repayment. These are the concepts of "financial feasibility" and "future savings."
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Wednesday, September 30, 2009
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2 comments:
Here is a thought experiment. Is there a practical way to get money into the hands of people who lack it so that they can use it to acquire capital? Do we have to rely on savings for capital formation? I have been struggling with this question for many years.
Recent history proves that there are no limits to how much money the Fed can create. What if those trillions of dollars were used not to bail out insiders but instead to make an interest free loan of say $100,000 to every American citizen? Say this money could be used only to purchase a portfolio of conservative dividend yielding investments with the loan being retired by the earnings of the portfolio.
What would the effect be? One effect would be to drive up the price of eligible investments. Would the prices climb so high that the earnings of the portfolio would not suffice to pay off the loan?
Good points. "Capital Homesteading for Every Citizen" outlines a feasible program for getting interest free loans to people for the purchase of capital assets. It wouldn't be $100K, for only cir. $7K of new capital is formed each year, but over a lifetime people would accumulate an estimated $500K of assets, and enjoy dividend income of cir. $1.6 million. Nor would it be inflationary, per the work of Moulton in "The Formation of Capital."
The money would not first be created, but created only when a new capital project is financed. Nor would it be used for existing capital, only NEW capital; this would remove the primary danger of inflation. The key is that no money exists until there is a discrete present value of existing or future marketable goods and services to back it. Don't get trapped by the Keynesian assumption that you first create money, then invest it, no, you create money BY investing -- it's a different "school" of finance, and one based on reality and classic banking theory.
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