Thursday, June 10, 2010

Out of the Depths, Part IX: Production is the Key

Admirers of and apologists for Prince Otto Leopold von Bismarck-Schönhausen have a hard time dealing with the Franco-Prussian War. Either the subject is completely ignored, or it is passed over so briefly as to make the reader think that nothing much of any importance happened. (Vide Erich Eyck, Bismarck and the German Empire. New York: W. W. Norton, 1958; A. J. P Taylor, Bismarck: The Man and the Statesman. New York: Viking, 1967.) Formerly secret documents declassified in 1957 make it painfully clear that the soon-to-be Chancellor of the Reich shamelessly manipulated people and events, even his own future emperor, to provoke a war with France. (Eyck, op. cit., 186.) Similarly, the Commune and its rule of the city in the wake of the Siege of Paris has been sanitized and reinterpreted to fit whatever political theory suits whoever happens to be in power at the moment.

Our concern, however, is not with the war itself, nor the Paris Commune, but with the indemnity Prussia imposed on France. The Franco-Prussian War officially ended on May 10, 1871 with the signing of the Treaty of Frankfurt. War had raged for five months. It had cost an estimated quarter of a million lives, Prussian and French. The question was now the indemnity France was to pay for having lost the war so artfully arranged by Bismarck.

Billion Dollar Indemnity

Bismarck's first demand was for 6 billion Francs. When the French threatened to walk away from the table, he immediately lowered it to 5 billion, or just short of $1 billion in terms of United States dollars at the then-current rate of exchange. Biographers and historians ever since have stated that this clearly indicated that Bismarck was fully aware that he was making an outrageous demand, and did not expect to get immediate agreement. Perhaps, but it is highly unlikely that the German Chancellor would have turned down the additional billion had the French agreed to pay.

In any event, from Bismarck's perspective there was little chance that France would be able to pay an indemnity of any amount. This appears to be, in fact, what he was counting on to ensure that the new German Empire-in-formation would be the most powerful nation in Europe.

Bismarck, however, failed to take two things into account. One, people have a natural tendency to side with the underdog. When Bismarck tricked France into the war, the Second Empire was decidedly unpopular in Europe and elsewhere. Those friends France did have were all-but powerless. Austria-Hungary had been humiliated in the Six Weeks War barely five years before and was seen as completely ineffectual. The Poles in the Prussian portion of occupied Poland, while vocal in support of the French, were confined to verbal barrages — for which they later paid a heavy price.

Allies in the southern German states on whom France had counted turned out to have entered into secret treaties to support Prussia. This was the case with Bavaria, Baden, and Württemberg. In addition to the treaties, these states also bowed to public opinion, stirred by Bismarck and resurgent German nationalism into a white heat against their Catholic ally. Groups such as the Young Germany Movement, which was also responsible for the artistic atrocity of the Teutoburgerwald Monument — the bombastic and mis-proportioned Hermansdenkmal — had nurtured support for Prussia. This would ultimately work to their disadvantage once the new Empire was secure and Bismarck initiated the anti-Catholic Kulturkampf. Bismarck also implemented a program of imposing Hochdeutsch, the Prussian dialect of German, and other aspects of Prussian culture on the southern states in an effort to inflict his personal vision of what it means to be German on everyone.

Still, when the tide of war obviously turned against France, public feeling started to go against Prussia, now seen as an international bully. When war was declared, a large number of Italians had volunteered for the Prussian Army, and a Prussian diplomat paid a visit to Garibaldi in Caprera. After the Battle of Sedan, Bismarck's obvious opportunism and escalating demands, such as for the return of the province of Alsace, disgusted former sympathizers. Even though Garibaldi viewed France, with its thwarting of his attempted takeover of the Papal States, as an enemy, he immediately issued a statement to his Red Shirts that, "Yesterday I said, 'war to the death to Bonaparte.' Today I say, 'rescue the French Republic by every means'."

Consequently, when the war was over, sympathy for France was at an all-time high. French goods, especially wine and wool, began to be in very great demand everywhere. This was especially the case in the United States. The rising "Robber Barons" of the industrial and merchant classes, newly enriched by the American Civil War, badly needed to show off their sophistication, particularly with imported French wine, silk, cheese, and other luxury goods. If France could produce it, France could sell it to a very willing world market.

This brings in the other thing Bismarck had evidently not counted on: Louis Pasteur, a French chemist, at this time renowned as one of the leading scientific minds in the world. Thomas Huxley was later to declare that the monetary value of Pasteur's discoveries was sufficient to cover the entire cost of the indemnity paid to Prussia.

The Power of Science

Pasteur's discoveries — at least those with a direct bearing on this series — began with a way to treat wine to prevent it from becoming sour. In 1862 Pasteur realized that the application of heat would kill the microorganisms that caused the problem. In his honor the process is called pasteurization. It has been widely applied to other liquids, notably milk. An interesting "might-have-been" in history is that a few years previously Gail Borden, Jr., seeking a way to make milk safe for more than a few hours, invented a vacuum pan that would allow him to heat milk without scorching it in order to "condense" the liquid and can it. In a sense, Borden could be said to have invented pasteurization before Pasteur.

Soon after Pasteur's discovery saved the French wine industry, it was discovered that some unknown disease was destroying the French silk industry. A friend — an unverified source claims it was the novelist Alexander Dumas — urged Pasteur to look into the problem. At first reluctant (he had never so much as seen a silkworm) he went to the south of France in the summer of 1865. By September he announced that he had found a cure.

If we understand the description correctly, the process Pasteur perfected involves first isolating the cause of the disease. The researcher then grows the organism under laboratory conditions. He or she then introduces factors that weaken the organism artificially so that, while it can no longer cause the disease, it can still stimulate the body to produce a defense against it — which defense is fully effective against the organism at full strength. This was an improvement on Edward Jenner's technique, which required that a naturally weak strain of the disease be located. In the case of smallpox, the weaker strain was the less virulent cowpox. (If this description is incorrect, it is entirely due to this author's misunderstanding of Pasteur's technique.)

It's a tossup as to who was more delighted: Pasteur, or the multitudes dependent on the silk industry for their livelihood. As he said, "There is no greater charm for the investigator than to make new discoveries; but his pleasure is heightened when he sees that they have a direct application to practical life."

Nor was the silk industry the only one to benefit from Pasteur's discovery. After finding a cure for the disease that was attacking the silkworms, Pasteur turned his attention to chicken cholera. This disease was decimating — literally — French poultry, being responsible for wiping out one in ten of the flocks. After the administration of Pasteur's treatment, the death rate was reduced by more than 90%.

After cholera came anthrax, a disease that was devastating sheep and cattle all through France. Having been ridiculed by the French Academy of Medicine, Pasteur took himself to the district of Arbois in eastern France. There he spent a decade investigating the causes of anthrax and, almost miraculously, developed an effective vaccine, which he distributed to the farmers in Arbois.

In recent years there seems to have been a movement to have Pasteur declared a fraud and a scientific cheat because a close study of his notes allegedly reveals that his method of isolating the anthrax bacillus did not produce the strain from which he created the vaccine. The bottom line, however, is that, whatever method was used to produce the strain from which Pasteur developed the vaccine, the unquestioned fact remains that Pasteur developed the vaccine. The flocks were saved.

Desperate for new sources of revenue to meet the 5 billion Franc indemnity, the government sent investigators to Arbois to find out why the sheep in that district were healthy when all across France sheep and cattle were dying in droves. Pasteur informed the committee of his discoveries, and was once again attacked and ridiculed as both a knave and a fool. Only after it was proved beyond a shadow of a doubt that the vaccine worked was it distributed throughout France and, later, the world — reducing the death rate from anthrax to under 1%.

Production is the Key

The upshot of Pasteur's discoveries was that France was able to produce the vast quantities of goods and services needed in order to generate the cash required to meet the indemnity payments. This was a graphic demonstration of Say's Law of Markets. Say's Law is a common sense observation that production equals income. Consequently, demand generates its own supply, and supply its own demand. As Jean-Baptiste Say explained the matter to the Reverend Thomas Malthus,
Since the time of Adam Smith, political economists have agreed that we do not in reality buy the objects we consume, with the money or circulating coin which we pay for them. We must in the first place have bought this money itself by the sale of productions of our own. To the proprietor of the mines whence this money is obtained, it is a production with which he purchases such commodities as he may have occasion for: to all those into whose hands this money afterwards passes, it is only the price of the productions which they have themselves created by means of their lands, capital, or industry. In selling these, they exchange first their productions for money; and they afterwards exchange this money for objects of consumption. It is then in strict reality with their productions that they make their purchases; it is impossible for them to buy any articles whatever to a greater amount than that which they have produced either by themselves, or by means of their capitals and lands. (Jean-Baptiste Say, Letters to Mr. Malthus on Several Subjects of Political Economy and on the Cause of the Stagnation of Commerce. London: Sherwood, Neely & Jones, 1821, 2.)
Not only was the indemnity, obviously intended to cripple France forever, paid in full, it was paid off ahead of schedule. Bismarck was evidently unaware that as long as a country can produce marketable goods and services, there is no need to use existing accumulations of savings for anything except consumption. A financial and economic reactionary (and a political progressive only when it suited him), Bismarck evidently looked only at France's existing accumulations of savings, not at French productive capacity in setting the amount of the indemnity. This appears to be the same mistake made by world leaders today, and their incomprehensible reliance on Keynesian deficit spending to bring about what only increased production can accomplish.

In this, the German Chancellor outsmarted himself, something that many of today's politicians and policymakers have acquired the habit of doing. Bismarck succeeded in laying the foundation of long-term enmity between France and Germany, as well as giving cause for lasting resentment for the 5 billion Francs shipped to Berlin, mostly in silver.

The Slavery of Savings

In Bismarck's relying on silver we find another instance of his being a little too clever for his own good. He was evidently convinced that gold and silver were "real money." Consequently, he — in common with today's academic economists and policymakers — seems to have believed that draining so much financial capital out of France would permanently cripple French industry and economic development.

This was a serious mistake. The price of silver was dropping rapidly at this time. Not only was production booming, the British had finally given up trying to finance the economic development of India by massive purchases of silver, sometimes more than annual world production. (Karl Helfferich, Money. New York: The Adelphi Company, 1927, 134.) World markets were glutted with a virtual tsunami of silver. This made it much easier for France to purchase silver on the world market cheaply — and ship it to Germany after minting it into Five Franc pieces at the agreed-upon standard. The massive influx of silver undermined the stability of the German states' currencies, most of which were based on silver, as they had been for nearly 2,000 years. When he put through the monetary reform for the new Reich, Bismarck found himself forced on to the gold standard, or he would have had to deal with serious inflation as the price of silver plunged. In real terms, the indemnity France paid may have been as low as two-thirds to a half of its nominal value, or even lower.

The key to understanding Bismarck's mistake is that he clearly didn't realize that existing accumulations of savings are not generally used to finance capital formation directly. Instead, savings (which necessarily equals investment) most commonly serve as collateral for the extension of bank credit. Just as good as collateral — even better, actually — is a market where people are (in effect) standing in line to purchase everything you can produce. You do not need existing assets — savings — in order to borrow from the bank. All you need is a solid contract with someone ready, willing, and eager to buy your good or service. With the high demand for French products at this time, especially wine, wool, and silk, the French had all they needed to generate sufficient cash to pay the indemnity without liquidating existing investment or inhibiting future economic growth.

Ironically, the Iron Chancellor may have done France a favor by imposing the indemnity. The French economy was in ruins as a result of the war. By creating an incentive to rebuild the French economy as fast as possible, Bismarck laid the foundation for what many people still today believe to have been the highpoint of French culture and civilization. He didn't get any thanks for it (nor did he deserve any), but Bismarck was unable to prevent the good that resulted from his evil.

Lessons for Today

Modern politicians as well as academic economists and policymakers can learn a great deal from France's experiences — both good and bad. Most obvious, of course, is for them to realize that the State cannot simply continue to create money for government spending, to bailout failed companies, or increase consumer spending (and thus government and consumer debt). Instead, the only safe and sound method of money creation is to back all new money with a private property claim on the present value of existing and future marketable goods and services, not government debt backed by possibly ephemeral tax collections.

Perhaps a more valuable lesson to learn, however (due to its immediacy), is that you cannot get out of a hole by digging it deeper. France did not pay off the Prussian indemnity by printing money and increasing the national debt — inflating and depreciating itself out of the hole it was in. In all likelihood, that would simply have caused another war with Germany when the Second Reich attempted to collect on the depreciated paper.

Instead, the French began to produce marketable goods and services at a tremendous rate in order to generate income with which to pay off the indemnity. They did not redistribute an existing pool of wealth through deflation and devaluation. In this, they took the advice of Harold Moulton more than half a century before he gave it:
Production and employment are basic and ultimate points of reference in modern industrial life. Depression, like prosperity, is a phenomenon which is significant primarily in these terms, and no understanding of the factors of recovery may be gained without a thorough consideration of these two elements of economic activity. (Harold G. Moulton, The Recovery Problem in the United States. Washington, DC: The Brookings Institution, 1936, 114.)
From that perspective, today's economic crisis is actually an opportunity. If our politicians and policymakers continue on their present path, of course, the situation will only get worse. If, however, they stop throwing good money after bad and start fostering production instead of speculation and gambling and relying on redistribution of existing wealth to meet people's needs, we can expect to see a phenomenal turnaround in the world's economy. The only question is, what program would be most effective in fostering production, stabilizing the currency, and increasing and sustaining consumer demand?

The Just Third Way and Capital Homesteading

The principles of the Just Third Way, distilled from the binary economics of Louis Kelso and Mortimer Adler combined with the act of social justice as analyzed by William Ferree in a synergistic program called Capital Homesteading for Every Citizen would seem to fit the bill. To the three principles of economic justice we noted at the beginning of this series we add the four pillars of an economically just society:
• A limited economic role for the State,

• Free and open markets as the best means of determining just wages, just prices, and just profits,

• Restoration of the rights of private property, especially in corporate equity, and (the "fatal omission" in all the major schools of economic thought),

• Widespread direct ownership of the means of production, individually or in free association with others.
Capital Homesteading is a Just Third Way comprehensive national economic strategy for empowering every American citizen, including the poorest of the poor, with the means to acquire, control and enjoy the fruits of productive corporate assets. It is not sufficient simply to foster production — it must be production in which everyone can participate as owners of both labor and capital.

Naturally we cannot give even an adequate summary of the proposal here. As it relates to the issues covered in this series, however, Capital Homesteading involves major restructuring of the tax system and central bank policies to lift unjust artificial barriers to more equitable distribution of future corporate capital and faster growth rates of private sector investment. The result would be to shift primary national income maintenance policies from inflationary wage and unproductive income redistribution expedients, to market-based ownership sharing and dividend incomes.

The central bank would distinguish between "sound" and "unsound" uses of credit naturally, through the structuring of the system itself. The central bank would provide interest-free (but not "cost-free") reserves by rediscounting eligible loans extended by commercial banks. One of the eligibility requirements for rediscounting would be that the loans are made in such a way as to enable every American to become an owner of a viable accumulation of new income-producing assets. This would reduce America's dependency on existing accumulations of savings, corporate retained earnings, or foreign government wealth funds advantaged by America's growing trade imbalances.

Thus, the central bank would supply sufficient money and credit through local banks to meet the liquidity and broadened ownership needs of an expanding market-disciplined economy. Loans, of course, would be subject to appropriate feasibility standards administered by the banks, and limited only by the goal of maintaining a stable value for the currency. Unsound uses of credit, such as the speculative credit that created sub-prime home mortgages and the global financial meltdown, would be financed from the accumulations of the wealthy who can afford the risks.

To ensure adequate oversight of the system, each citizen would receive a single, lifetime, non-transferable voting share in the central bank. This would ensure that the directors and administrators of the system are broadly representative of all groups affected by central bank policy, and that power over future money creation is spread widely among all citizens.

Capital Homesteading's central focus is the democratization of capital (productive) credit. By universalizing citizen access to direct capital ownership through access to interest-free (but not cost-free) productive credit, it would close the power and opportunity gap between today's haves and have-nots, without taking away property from today's owners.

There is much more, of course, but the lesson is clear. There is only one way to get out from under the colossal burden of debt faced by the United States and the rest of the world: produce — and produce in a way in which everyone shares in the process both through ownership of labor and ownership of capital. You can't redistribute by printing money forever. At some point the bill comes due. Devaluing the currency is not going to make the problem go away. The United States not only should, but must adopt Capital Homesteading for every citizen as soon as possible.


1 comment:

nail-in-the-wall said...

I can’t imagine what Louis Kelso would say about your latest series, but I would imagine it as something like this:

“We hope that this essay has contributed to an understanding of the cost industrialized countries are incurring through the persistent blindness of their leadership to the rationale of free industrial society, and of the coin in which payment will be exacted. Since the very purpose of an expedient, as opposed to reasoned action in harmony with relevant and sound principles, is to temporize, to gain time, to push the dislocations and problems downstream to those who come afterward, guardians of the status quo will probably escape the consequences of the leadership. They can say with Louis XV, "Apre’s moi, le deluge.”
Therefore, it is unlikely, although not impossible, that changes and innovations will be initiated by the exponents of the “conventional wisdom.”

Our hopes of change will be more realistically placed in those who will have to pay the full cost of economic mismanagement. To identify them takes no special prescience. They are the ones who must always suffer for defective economic institutions -the propertyless of all ages, but most particularly and immediately, their children [our posterity].”

Support the Just Third Way Generation.
Pass Capital Homesteading Now!

How to Turn Eighty Million Workers into Capital Homesteaders on Borrowed Money and Other Proposals. (pg 155)Louis Kelso

Long live the Revolution of idea,..