Say's Law of Markets, Part IV: An Overview of Commercial Banking

As we have seen, banking in a real sense began thousands of years before the invention of what most people think of as "money." The elements of true banking, properly understood, developed early on in ancient Egypt and Mesopotamia. A bank is not simply a financial institution that takes deposits and makes loans — although it can be that, and many types of banks down to the present day operate in this fashion. These "banks of deposit" are known as credit unions, savings and loans, cooperative banks, mutual loan societies, micro-lending, investment banks, and so on.

Capital Formation with Existing Savings

Deposit banking, however, is not an irreplaceable function in an economy. Anyone with an existing accumulation of funds can, assuming he or she is willing to lend those savings, serve as a bank of deposit. The problem is that, when the rate of economic growth is tied exclusively to existing accumulations of savings, it is necessarily slow, and tends to benefit those at the top much more than those at the bottom. As technology advances in a system in which the financing of new capital is tied to existing accumulations of savings, the gap between the haves and the have-nots, absent coercive redistribution through government mandate, inflation or the tax system, tends to widen dramatically.

In order for rapid and sustainable economic development to take place, two critical factors need to be in place in a society. One, there needs to be widespread direct ownership of the means of production. Two, there needs to be a financial system that can turn potential production of marketable goods and services into actual marketable goods and services by providing adequate financing for capital projects.

When we assume as a given that only existing accumulations of savings can be used to finance new capital, both of these factors are dismissed, ignored, or actively opposed. This is understandable. Within a system that admits only existing accumulations of savings can be used to finance new capital formation, then as technology advances, ownership of the means of production must become increasingly concentrated. This is because, in order to finance the increasingly expensive advanced capital, there must be individuals who can afford to refrain from consuming all of their income.

In general, only those who are already wealthy can afford to refrain from consuming all of their income. In fact, when an individual wealth accumulation reaches a certain point, it becomes impossible for a single individual to consume all that his or her capital produces. He or she is forced to save the vast amount of income generated, or give it away.

This presents the "past savings" economist with a dilemma. If the wealthy are taxed in order to redistribute their income, or they give away the bulk of their wealth or income as charity — alms — the economy will not have sufficient savings available to finance new capital formation. This in turn means that no new jobs will be created, and consumption will fall. Existing jobs will start to disappear, which will accelerate the decline in consumption, causing more jobs to disappear, and so on, in a vicious circle.

If, however, the wealthy reinvest all of the income that they are unable to consume, new capital is formed, and new jobs are created. Unfortunately, the fall in consumption that results from diverting income from consumption to investment means that the new jobs will not be sustainable. Without a sufficient level of effective demand in the economy, marketable goods and services will either remain unsold, or will not be produced in the first place. Workers will be laid off, existing consumption power will decline, and the economy start to decline in a vicious circle.

The Keynesian Solution

In order to counteract the negative effects resulting from reliance on existing accumulations as the sole source of financing for new capital formation, John Maynard Keynes advocated State manipulation of money and credit, and (a surprising revelation possibly even to Keynes) effective abolition of the institution of private property in the means of production.

We won't waste too much time proving this latter claim. In brief, as Louis O. Kelso pointed out, "Property in everyday life, is the right of control." (Louis O. Kelso, "Karl Marx: The Almost Capitalist," American Bar Association Journal, March, 1957.) "Control," of course, must be correctly understood when talking about private property. Control means the right to decide what to do with what you own, that is, how to allocate or dispose of your resources. It also means the right to decide what to do with the income generated by what you own: the "fruits of ownership."

Any time the State or anybody or anything else tells you how you must use what you own, or how much income you are permitted to receive from what you own, you cannot really be said to own it. You may hold "official" legal title, but the real owner is who- or whatever controls how you allocate what you own and how much income you are permitted to enjoy.

We must be careful at this point, however, not to confuse the necessary and just limitations society imposes on the exercise of property, with the unjust infringement on the rights of owners through illicit imposition of control. In general, no one may use what he or she owns to harm him- or herself, other individuals, groups, or the common good as a whole.

As for manipulation of money and credit by the State, this is (as Friedrich von Hayek pointed out — unfortunately without realizing the implications of his own reliance on existing savings) as fully collectivist as outright socialism, and as unjust. The Keynesian "fine tuning" of the economy by controlled inflation and setting of interest rates deprives wage earners of the value of their wages, and inhibits new capital formation that creates jobs and presumably replaces the effective demand eroded by inflation.

Unfortunately, locked into the assumption that only existing accumulations of savings can be used to finance new capital formation, Keynes recommended that the State take over both allocation of resources and dictate the rate of return owners are permitted to realize from what they own. (John Maynard Keynes, The General Theory of Employment, Interest, and Money (1936), VI.24.iii.) His language was deceptively mild — so much so that one suspects that Keynes didn't really understand the implications of what he said. He may even have believed that the presumed necessity of State control of the economy outweighed all other considerations — that the end justified the means.

Given the assumption that existing accumulations of savings are the only source of financing new capital formation, Keynes was absolutely correct. We even find support for Keynes's position in classic moral philosophy. If there is no possible way for someone to obtain what he or she needs to support him- or herself and his or her dependents in a manner consistent with the demands of human dignity, then justice demands that those with a monopoly on the means to sustain life redistribute an amount sufficient to sustain the life and health of those cut off from the means to take care of themselves and their dependents.

The Just Third Way Solution

The problem with the Keynesian solution, however, is that it is based on a false premise: that Say's Law of Markets does not operate because only existing accumulations of savings can be used to finance new capital formation. If this premise is false — and we will demonstrate in a moment that it is utterly false — then what is presented as "justice" becomes an exercise of raw State power, an act of tyranny of the worst sort.

The fact of the matter is that, given the nature of money as a derivative of the present value of existing and future marketable goods and services, the financing of new capital is not dependent on existing accumulations of savings. As Dr. Harold G. Moulton, president of the Brookings Institution from 1916 to 1952 showed in his 1935 classic, The Formation of Capital, the rate of new capital formation is not tied to the amount of savings currently existing in the system. In point of fact, if existing accumulations are used to finance new capital formation, or even replacement capital to a significant degree, the financial feasibility of the new or replacement capital is seriously impaired.

Further, as Louis Kelso demonstrated time and again, the small ownership that Keynes believed should be eliminated from the economy (General Theory, op. cit., VI.24.ii) is, in fact, absolutely necessary if Say's Law of Markets is to function. The problem of course, is that even if we accept the desirability of widespread direct ownership of the means of production, and even if we admit the possibility that Say's Law is valid, we still don't know how people without ownership can gain ownership.

Actually, that's not entirely correct. We do know how people without ownership of capital can acquire capital. The nature of money and credit tell us how. All we need do is come up with marketable goods and services that have a present value, whether those goods and services exist now, or can be manufactured or provided within a reasonable ("feasible") period of time. We can draw a bill of exchange on the present value of the marketable goods and services we have produced or will produce, and use the bill to carry out transactions.

The Bank of Issue

The problem is that not everyone may know or trust us. What we need is a financial institution that can transform our individual purchasing power, represented by the bill of exchange we have drawn on the present value of the existing or future marketable goods and services that we own, i.e., in which we have a private property right, into general purchasing power that everyone accepts without having to worry whether we will make good on our promise to deliver what we have promised.

Fortunately, such institutions exist. They are custom-made to transform individual purchasing power into general purchasing power. That is, these institutions change one form of money into another form of money. These institutions are called "Banks of Issue," and are most familiar today in the form known as commercial banks.

A commercial bank is designed to operate in this manner. A borrower takes his or her bill of exchange to a commercial bank. A loan officer scrutinizes the bill, investigates the creditworthiness of the borrower, examines what is offered for collateral and, if everything checks out, "discounts" the bill, which then becomes a "banker's acceptance." (When a bill of exchange is used in a transaction between two individuals or companies one of which is not a bank, it is called a "merchant's acceptance.") If the bank (or merchant) uses the bill of exchange in a subsequent transaction, passing the bill on to another holder in due course, the process is called "rediscounting."

This is called discounting or rediscounting because instead of charging interest on the service provided, a bank or holder in due course accepts the bill at a discount from the face value. For example, if a borrower presents a bill of $100,000 to a commercial bank for discounting at 2%, the bank creates a demand deposit (or, formerly, printed banknotes) in the amount of $98,000. When the loan is repaid at the full rate of $100,000, the bank cancels the $98,000 and books $2,000 in revenue. (Obviously, if the bank rediscounts the bill with another holder in due course, it will be at a higher discount, or it will lose money — but the original borrower is still only obligated for the face value of the note.)

Legitimate Use of Past Savings

If that were as far as it went, it would be possible for commercial banks to create money without any need whatsoever for existing accumulations of savings. Two factors, however, intervene that appear to upset this arrangement and inhibit or prevent people without existing ownership or savings from becoming capital owners. One is the need for cash reserves to redeem obligations issued by the bank that are not used to repay loans. The other is the demand for collateral.

When gold and silver circulated and were accepted everywhere as money, bank reserves had to be in gold and silver, or gold and silver equivalents, i.e., certificates redeemable in gold on demand. That is no longer the case, but bank customers may still want "cash money" instead of a check or bank-issued promissory note.

Fortunately, central banks and national banks (the difference need not concern us at this point) were invented to address this problem. Even if specie — gold and silver — does not circulate, the paper certificates issued or demand deposits created by the central bank can be used as reserves by commercial banks. There need never be a shortage of reserves in an economy served by a central bank. Any commercial bank in need of additional reserves should be able to rediscount some or all of its loans at the central bank, thereby giving every commercial bank that has rediscount privileges potentially 100% cash reserves behind its demand deposits.

That leaves the question of collateral. Typically, collateral is in the form of existing inventories of marketable goods and services, or (more common) the general creditworthiness of the borrower backed up by the present value of his or her existing capital assets. When the creditworthiness of a borrower is in question, a bank may demand other forms of collateral, such as marketable securities or a guarantee by a respected and wealthy individual willing to co-sign a loan.

This is actually the real use of existing accumulations of savings in a modern economy. Capital formation is not typically financed out of accumulated savings. Instead, accumulated savings — almost always already invested in productive capital — are pledged as collateral for a loan used to create new money. The new money — not the existing savings — is used to finance new capital formation. If the project proves feasible, the loan is repaid, and the collateral released back to the borrower. If the project does not prove feasible and the loan goes into default, the lender seizes the collateral.

The problem is, again, that if a prospective borrower does not have savings, neither does he or she have investments — savings and investments are, generally speaking, interchangeable as collateral for all practical purposes. People without savings or existing ownership of capital still cannot purchase the capital they need to generate an adequate and secure income even if the banking system has freed itself from the "slavery of savings."

There is, however, an answer, as Kelso pointed out. Collateral is simply a form of insurance. That being the case, the universal demand for collateral can be replaced with capital credit insurance and reinsurance. The usual "risk premium" charged on all loans in any event can, instead, be used as an actual insurance premium. The initial insurance and reinsurance pools would, admittedly, have to be provided out of existing savings or, in a pinch, guaranteed by the government as an expedient until sufficient premiums can be accumulated.

Taking a Wrong Turn

The only question that remains, then, is how, if a financial system based on Say's Law of Markets and its application in the real bills doctrine used to ensure widespread direct ownership of the means of production is so rational, and so obviously beneficial to the economy and the social order as a whole, how did we ever get into the mess we have today? All things considered, all that should have been necessary would be to present the arguments and the proofs for the validity of Say's Law and the clear advantages to be derived from broadened capital ownership, and the problem should solve itself.

This was, in fact, what the Brookings Institution did under the direction of Dr. Moulton in the 1930s. At a time when Say's Law was beginning to fall out of favor and commercial banks and central banks — notably the Federal Reserve System — had, to all intents and purposes, completely abandoned the real bills doctrine, the Brookings Institution published a series of four books presenting an alternative to the New Deal as the framework for economic growth and recovery from the Great Depression. These books, America's Capacity to Produce (1934), America's Capacity to Consume (1934), The Formation of Capital (1935), and Income and Economic Progress (1935) — especially The Formation of Capital — examined the economic and, especially, the financial system in light of the meltdown that followed the Crash of 1929.

Moulton's conclusion as principal author was that reorienting the financial system back to its original purpose — especially the central bank, the Federal Reserve System — would provide a sound foundation on which to rebuild the American economy. In contrast to Keynesian economics, which postulated that lack of effective demand was the problem, and that matters could be put right by devaluing the dollar and inflating the currency to redistribute purchasing power, Moulton stated that neither supply nor demand was the real problem. The United States had the inherent capacity both to produce and to consume — both necessarily go together, a tacit reaffirmation of Say's Law of Markets.

The real problem was connecting supply and demand without harming either the country's capacity to consume or to produce. Saving to accumulate the financing for capital investment causes the capacity to consume to diminish, while using all income for consumption — according to Keynes — dried up the supply of savings required to finance new capital formation. As Moulton pointed out, however, the assumption of the necessity of existing accumulations of savings as the sole source of financing for new capital formation is not only false, but harmful, in that it throws a monkey wrench into the workings of the economy.

Unfortunately, the belief that only existing accumulations of savings can be used to finance new capital formation had been around for over a century by the time the Brookings Institution published Moulton's findings, and it was well entrenched. President Roosevelt and his advisors listened to Keynes, not to Moulton, with the results that we see today.

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CESJ's Orientation in Brief

CESJ is a non-profit think tank organized under IRC 501(c)(3) to study the principles and application of the social doctrine of Pius XI as analyzed by Father William Ferree, S.M., Ph.D., "America's greatest social philosopher," and the principles of economic justice developed by Mortimer J. Adler and Louis O. Kelso. Based on a classic Aristotelian/Thomist natural law orientation, CESJ posits personalism — a positioning of the human person who, in the Judeo-Christian belief is made in God's image and likeness, at the center of things — as being the overriding philosophy, the Just Third Way as "political personalism," and "Capital Homesteading" as a possible application of "economic personalism."

The Just Third Way consists of the "Four Pillars of an Economically Just Society": 1) A limited economic role for the State. 2) Free and open markets as the best means of determining just wages, just prices, and just profits. 3) Restoration of the rights of private property, particularly in corporate equity, and (the "fatal omission" from mainstream economics and finance), 4) Widespread direct ownership of the means of production.

Economic activity is necessarily focused on the human person. For this reason CESJ concentrates on integrating the precepts of the natural moral law into the financial and economic system — the primary means by which humanity satisfies its material wants and needs, thereby supporting life — by tying people directly to the means of production, both labor and capital, through private property and exercise of liberty (free association). The three guiding principles of economic justice are 1) Distribution, 2) Participation, and 3) Harmony (formerly "Limitation").

As capital replaces labor as the predominant factor of production, it becomes essential that people acquire and possess capital so that they have the power to acquire and develop virtue and interact as full participants in the common good. Individual and social justice therefore both demand that artificial barriers to full participation in the common good be eliminated so that each person has an equal opportunity to become an owner of both labor and capital through access to capital credit, a uniquely "social good."

The most significant barrier to widespread direct ownership of capital is the dogmatic belief that only existing accumulations of savings can be used to finance new capital formation. On the contrary — the natural right of private property as applied in Say's Law of Markets and the real bills doctrine makes it clear that "money" is simply a symbol, a "derivative." Money is the means for conveying a private property right in the present value of existing and future marketable goods and services.

Because everyone has the natural right to participate in production by means of his or her labor and capital, everyone has the right to participate in the creation of "money" for productive purposes. Modern commercial banking backed up with a properly designed and implemented central banking system has the potential to open up capital ownership to all without the necessity of first saving, thereby (as Kelso and Adler phrased it in the subtitle of their second book, The New Capitalists), freeing economic growth from the slavery of [past] savings, particularly when the universal demand for collateral is replaced with capital credit insurance and reinsurance.

A program of expanded capital ownership called "Capital Homesteading," financed with "pure credit" has the potential to reorient the global economy to closer conformity with the precepts of the natural moral law and respect for human dignity. As Dr. Harold G. Moulton, first president of the Brookings Institution, explained in his landmark monograph The Formation of Capital (published in 1935 to present an alternative to the Keynesian New Deal), new money can be created for productive capital investment through expansion of bank credit by borrowers discounting eligible paper at commercial banks and rediscounting the paper at the Federal Reserve.

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News from the Network, Vol. 3, No. 34

Judging from the increase in news stories reporting a growing dissatisfaction with the ineffectual actions of the Obama Administration to bring the country out of the economic downturn, people are starting to realize that something is wrong. By and large, however, people are blaming President Obama personally for the situation. Not to be outdone, Mr. Obama turns around and blames Past President Bush.

It's the System, Stupid

What people don't seem to be grasping is the fact that neither Obama nor Bush are the causes of today's societal malaise, but, to varying degrees, effects of a badly structured and poorly understood system and the philosophy embodied in the system. They are both creatures of their — that is, our — times. Both men, as well as virtually all others we regard as leaders, exhibit a failure to exercise the human capacity to rise above flawed ideologies and a defective institutional environment and work to improve the common good to bring it closer to conformity with the precepts of the natural law.

Both men, in conformity with the Zeitgeist that afflicts the west, have convictions more or less firmly held. These convictions, however, are rooted in a concept of society directly at odds with reality, that is, with the natural moral law based on God's Intellect, reflected in humanity, and discerned by reason alone. Both men, taken as exemplars of "conservative" and "liberal" (if those terms have any meaning beyond rhetorical flourishes and handy labels to remove the necessity of thinking), take for granted that there are things vaguely termed "morality," "justice," and "social justice."

Transubstantiating Reality

Within the framework of modern western civilization, and to oversimplify somewhat, "morality" changes into persuading others to do what you want them to do based on your interpretation of what some authority you accept has declared is "good." "Justice" in this distorted understanding is a mechanism for forcing others to give you what you want based on what you have decided is "good." "Social justice" is transformed from a virtue to a vice, a means forcing others to do what you want them to do based on what you have decided is "moral," another dirty word today.

In this diseased mindset, "morality" changes from conforming one's self to objective standards of right conduct based on human nature — striving for the good, as Aristotle phrased it in his Ethics — to a matter of opinion, based on personal desires and different for each individual and group. Something stops being right because of its inherent goodness. It gets changed into being "good" because we believe that someone has so commanded, and we accept that command because in our opinion it is good — a bizarre piece of à priori reasoning. In this distorted belief system, if I agree with someone's opinion, his or her morality is good. If I disagree with someone's opinion, his or her morality is bad. Another term for morality within this mindset is "faith."

"Justice" becomes no longer a moral virtue, a part of morality, but removed from morality altogether. "Justice" becomes, in essence, the externalization of a personal desire, a way of glorifying selfishness. The understanding of justice changes from rendering to each what each is due, to coercive measures imposed on others to get me what I want. Justice, too, is a matter of opinion, but (unlike morality) can legitimately be forced on others if I, justifying my actions by redefining basic terms, can acquire enough power to do so. Another term for justice in the framework determined by Will rather than Intellect is "reason."

Given these new — and incorrect — definitions of morality and justice, "social justice" becomes a way of having your cake, and eating it, too. Social justice (or what people come to think of as social justice) combines morality and justice, or faith and reason, so that your opinion of something you accept as a moral authority can be forced on others. This understanding of social justice differs from morality in that it can be forced on others, while it differs from justice in that the one demanding it is doing it for the presumed good of others without necessarily demanding it for him- or herself. In certain cases, the one doing the demanding may even exempt him- or herself from the presumed benefits. Perhaps the best way of understanding social justice in this framework is coercive altruism, with someone else footing the bill.

A Restoration of the Natural Law

Given these understandings of morality, justice, and social justice, there is no way to correct the situation. Despite the growing conviction that there are fundamental flaws in the institutional environment within which humanity carries out the "business of living," there remains the even more fixed belief — virtually a religious dogma — that the proper corrective to social problems is to demand and implement greater and greater intrusion by the State, or to reduce the scope of the State's intrusion without correcting the flaws in the system that are causing the problems — replacing an ineffectual remedy with no remedy.

The fact is that religion and philosophy, or faith and reason, are both consistent with nature. Both faith and reason — religion and philosophy — are ways to transcend the constraints imposed by a specific culture. When we compartmentalize, that is, we separate faith and reason, or, worse, combine them and attempt to make one do the job of the other, we ensure that neither can be effective in helping us transcend the limitations of the system and help guide us in restructuring the system to conform more closely to human nature.

That is why a proper understanding of the natural moral law — a triple oxymoron in today's society, reminiscent of Voltaire's rather silly quip about the Holy Roman Empire that only demonstrated his lack of understanding of the institution — must be restored in its fullness before we can address the problems of modern society, whether economic or political, with any effectiveness.

That is why the Just Third Way, again to oversimplify somewhat, is directed toward the restoration of the natural moral law as the fundamental basis of society. Toward that end, here are the highlights of what we've been doing over the past week:

• On Monday we had what could turn out to be a very important meeting with someone who has connections with both the foundation world and the business community. More "relationship building" needs to take place, but there was great interest expressed in Justice-Based Management as one means of restructuring business to conform more closely to the principles underlying the Just Third Way.

• Thursday we had a telephone conference with a financial professional in Kentucky who is interested in applying ethical standards in the world of finance. Some interesting ideas and action items came out of the discussion, among them possible participation in the upcoming meeting in Chicago, and the concept of a "Foundation for Economic Justice and Development," below.

• Preparations for the Chicago trip proceed apace. We have arranged meetings with two potential key "door openers" in Chicago, and are working to bring in at least three more. The main thrust of the meetings is, of course, to start opening doors to and bringing together prime movers interested in the restoration of the natural moral law. A number of specific initiatives coming under the umbrella of the Just Third Way may also be discussed, such as Justice University, contacts with media figures, CESJ's recent publications (Supporting Life and The Formation of Capital), and the Foundation for Economic Justice and Development concept.

• As noted above, the concept of a Foundation for Economic Justice and Development developed during the Thursday telephone conference. The idea is that, under the current assumption of the necessity of past savings underlying the financial system, there are still some things that might be done to advance the Just Third Way. Obviously, the ultimate goal is, as Kelso and Adler put it in the subtitle of their second collaboration, The New Capitalists (1961), to "free economic growth from the slavery of [past] savings" by restoring Say's Law of Markets and the real bills doctrine to finance widespread direct ownership of the means of production, using the financial system to create money for productive uses instead of to finance government deficits. The question is, is there any way to begin implementing broad-based direct ownership while the financial system is trapped within the past savings assumption? Yes. The initiative would, frankly, be an expedient and take advantage of tax breaks given to non-profit foundations, but could be designed to be phased out or transformed into another type of foundation — perhaps along the lines of Robert Heinlein's concept of the "Long Range Foundation" from Time for the Stars (1956) — once Capital Homesteading is in place.

• By the merest coincidence this morning, the short "blogitorial" that opens these news items was composed before the Wall Street Journal was delivered. Immediately after writing the blogitorial, we watched Mike Wallace's interview of Mortimer Adler on a special series presented by ABC and "The Fund for the Republic" from September 7, 1958. This was because the video covers more or less the same subject that we wrote about. After all that, it almost seemed more than a coincidence on reading the Wall Street Journal to find an article on the revival of the thought of Leo Strauss. ("Leo Strauss, Back and Better Than Ever," WSJ, 08/27/10, W-9.) Strauss took the radical and insidious approach that, while applications of principles might change to reflect current conditions of society and to answer human wants and needs better, the principles themselves are eternally valid. Ever since liberal academics, journalists, and conspiracy theorists discovered that many people in the Bush administration had been influenced by Strauss (however much they probably misunderstood the full implications of his natural law orientation), Strauss has been transformed into a sort of anti-neo-con bogeyman, a "neoconservative Svengali," as Brian Bolduc, the author of the article, put it. This, of course, was only to be expected in a society in which our leading educational institutions have, to all intents and purposes, become morally bankrupt, and anyone with principles discerned by the use of reason instead of some private revelation of TRVTH is instantly suspect.

• As of this morning, we have had visitors from 41 different countries and 43 states and provinces in the United States and Canada to this blog over the past two months. Most visitors are from the United States, the UK, Russia, India, and Brazil. People in Venezuela, Guatemala, Bangladesh, Poland and the United States spent the most average time on the blog. The most popular posting is the one on "The Federal Reserve . . . This Time It's Personal," followed by last week's "News from the Network," then Geoff Gneuh's piece on "Money and Morals after the Crash," then "Aristotle on Private Property," and, finally, "Catching the Wave."

Those are the happenings for this week, at least that we know about. If you have an accomplishment that you think should be listed, send us a note about it at mgreaney [at] cesj [dot] org, and we'll see that it gets into the next "issue." If you have a short (250-400 word) comment on a specific posting, please enter your comments in the blog — do not send them to us to post for you. All comments are moderated anyway, so we'll see it before it goes up.

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Say's Law of Markets, Part III: The Real Bills Doctrine

It's a popular truism that you need money to make money, or that banks will only loan money to the people who don't need it. Fortunately, these aphorisms are only true — and even then only in a limited sense — within a paradigm circumscribed by a limited understanding of money and credit. These limits are, one, that money is a State-authorized purchase order, backed by the general wealth of the economy on which the State can draw by taxation, and, two, that only existing accumulations of savings can be used to finance new capital formation.

Must Wealth Be Concentrated?

As we have seen, if existing accumulations of savings are the only source of financing for new capital formation, then, as Keynes observed, based on these erroneous assumptions, the demands of economic development require the elimination of small ownership from society. Only the rich — and the richer, the better — can afford to cut consumption and save in the presumably necessary amounts required to finance modern capital. As Keynes declared, "The immense accumulations of fixed capital which, to the great benefit of mankind, were built up during the half century before the war, could never have come about in a Society where wealth was divided equitably." (John Maynard Keynes, The Economic Consequences of the Peace, 2.III.)

Unfortunately, capital has become the predominant factor of production in the modern advanced economy. Human labor (considered solely as an input to production) has become relatively less important in the production process. The ability to gain sufficient income from labor alone, absent subsidies, union coercion, or redistribution by the State via direct taxation or manipulation of the currency has all but disappeared as a significant factor in the modern advanced economy.

The problem, of course, is that if the worker cannot produce by means of his or her labor, and if the State does not engage in some form of redistribution, the worker cannot consume. Even worse, if someone cannot turn his or her existing or future production of marketable goods and services into money by drawing a bill and discounting it, the market will be restricted to those who have either accumulated sufficient savings, have jobs that pay them out of existing savings, or those who receive tax monies from the State and so have effective demand.

According to Say's Law, if the economy is in a slump and goods and services remain unsold, it is because a significant number of people are not able to produce by means of their labor or capital, and thus do not have their own productions to exchange for the productions of others. Government redistribution, tax rebates, and inflation do not solve this problem. Instead, such measures make matters worse by maintaining, even increasing the "ownership gap." When the system relies on existing accumulations of savings to finance new capital formation, the non-owning worker is cut off from owning capital, the predominant means of production.

The problem is thus that, the way the system is currently structured, only those who already own capital have the capacity to finance (and thus own) virtually all new capital. At the same time, those who own little or no capital and therefore desperately need to become owners of income-generating assets to supplement or replace labor as the predominant factor of production, do not have access to the existing accumulations of savings that presumably provide the financing for all new capital formation. The reliance on existing accumulations of savings automatically means that Say's Law of Markets will not function, because most people cannot replace lost labor income with capital income.

A Better Understanding of Money

Once we understand that money is anything that can be used in settlement of a debt, however, Say's Law of Markets can function. Chiefly this is through the operation of the real bills doctrine. Simply put, the real bills doctrine — ridiculed and rejected on specious grounds by the three major modern schools of economics — is that money can be created or cancelled without inflation or deflation under certain conditions. These are 1) The amount of money created or cancelled must never exceed the increase or decrease in the present value of existing or future marketable goods and services in the economy. 2) The issuer of the money, whatever form it takes, must have a private property stake in the present value of the existing or future marketable goods and services — or the capital that will produce the marketable goods or services in the future — that stands behind the promise that the money conveys.

The problem with the current understanding of money — we can't call it "old," for it is newer than the understanding of money embodied in Say's Law — is that authorities who adhere to the belief that existing accumulations of savings are the sole source of financing for new capital tend to ignore the need to increase production when goods are not being consumed. Say's comments about the "vulgar prejudices" holding that consumption — effective demand — should be increased and production ignored, bring Keynesian monetary and fiscal policy forcibly to mind. Rather than concentrate on production and employment in productive activity to bring an economy out of recession, Keynesian policy — like that of Malthus — concentrates on dividing up existing wealth into smaller and smaller portions. Keynesian monetary and fiscal policies do this by manipulating the currency and inequitable tax burdens, policies that discourage small ownership and force as many people as possible into the wage system and the proletarian condition.

The main problem that so-called "orthodox" economists see with Say's Law of Markets, then, is the question of where to get the money with which to finance the acquisition of capital and land by people who cannot produce enough by means of labor alone to enable them to cut consumption and accumulate sufficient savings with which to purchase non-labor means of production. Adam Smith explained it in "Book II" of The Wealth of Nations.

After explaining that money evolved out of a need to trade one individual's production of goods and services for those of others in terms of a common unit of value (Ibid. "Introduction"), Smith reiterated the fact that production, not money, equals income. "Money" is not itself revenue, but a measure of revenue:

Money, therefore, the great wheel of circulation, the great instrument of commerce, like all other instruments of trade, though it makes a part, and a very valuable part, of the capital, makes no part of the revenue of the society to which it belongs; and though the metal pieces of which it is composed, in the course of their annual circulation, distribute to every man the revenue which properly belongs to him, they make themselves no part of that revenue. (Ibid., II.ii)

That is, money is not purchasing power — value — because money is not in and of itself valuable. Rather, money as a measure of revenue conveys the purchasing power — the value — inherent in the present value of the marketable goods and services that "money" represents, and on which the issuer of the money has a legal claim.

That being the case, are the extremely expensive gold and silver "game markers" that can be used to settle debts and convey and store value strictly speaking absolutely necessary? Smith claimed not. It is, in fact, much more rational and efficient to use inexpensive paper, not costly gold and silver, as the currency:

The substitution of paper in the room of gold and silver money, replaces a very expensive instrument of commerce with one much less costly, and sometimes equally convenient. Circulation comes to be carried on by a new wheel, which it costs less both to erect and to maintain than the old one. But in what manner this operation is performed, and in what manner it tends to increase either the gross or the neat revenue of the society, is not altogether so obvious, and may therefore require some further explication. (Ibid.)

Smith then proceeded to describe the functioning of a bank of issue, the process of discounting, and the operation of the banking system in Scotland, which most closely approximated a country in which paper credit had largely replaced gold and silver credit. Whether money is gold and silver, or paper, is — so far as the money supply itself is concerned — a matter of indifference, except, perhaps, for the cost involved in producing a metallic currency.

The real issue is in the purpose to which money is put. If money is created (whether by minting or printing) and used for consumption, it "is in every respect hurtful to the society." (Ibid.) If, however, money is created and put to work financing capital formation, "it promotes industry; and though it increases the consumption of the society, it provides a permanent fund for supporting that consumption, the people who consume re-producing, with a profit, the whole value of their annual consumption." (Ibid.) As Smith explained,

It is like a new fund, created for carrying on a new trade; domestic business being now transacted by paper, and the gold and silver being converted into a fund for this new trade.

If they employ it in purchasing foreign goods for home consumption, they may either, first, purchase such goods as are likely to be consumed by idle people, who produce nothing, such as foreign wines, foreign silks, etc.; or, secondly, they may purchase an additional stock of materials, tools, and provisions, in order to maintain and employ an additional number of industrious people, who reproduce, with a profit, the value of their annual consumption. (Ibid.)

What Smith set out is the basic rule for money creation, whether the monetary medium consists of precious metal, paper, electronic blips, or a handshake. If money is created to spend on consumption, that is, on financing the purchase of goods and services that do not generate their own repayment, it is not only foolish (Ibid.), but causes actual harm to society. (Ibid.). If, on the other hand, money is created and spent in ways that generate repayment of the money, the process represents a positive good to the society. (Ibid.) We must always take care, however, not to confuse money with purchasing power, that is, mistake the symbol of value for the actual value that stands behind the symbol. As Smith explained,

When we compute the quantity of industry which the circulating capital of any society can employ, we must always have regard to those parts of it only which consist in provisions, materials, and finished work; the other, which consists in money, and which serves only to circulate those three, must always be deducted. In order to put industry into motion, three things are requisite; materials to work upon, tools to work with, and the wages or recompence for the sake of which the work is done. Money is neither a material to work upon, nor a tool to work with; and though the wages of the workman are commonly paid to him in money, his real revenue, like that of all other men, consists, not in the money, but in the money's worth; not in the metal pieces, but in what can be got for them. (Ibid.)

Smith emphasized that it is not the amount of money created that is the important thing, nor even the material from which it is made, but the use to which it is put. It is the productive creation of money, not the mere fact of money creation that should govern how we view this extremely useful instrument. Again, if money is created to invest in productive projects and not for consumption, it is a great boon to society:

When paper is substituted in the room of gold and silver money, the quantity of the materials, tools, and maintenance, which the whole circulating capital can supply, may be increased by the whole value of gold and silver which used to be employed in purchasing them. The whole value of the great wheel of circulation and distribution is added to the goods which are circulated and distributed by means of it. . . . When, therefore, by the substitution of paper, the gold and silver necessary for circulation is reduced to, perhaps, a fifth part of the former quantity, if the value of only the greater part of the other four-fifths be added to the funds which are destined for the maintenance of industry, it must make a very considerable addition to the quantity of that industry, and, consequently, to the value of the annual produce of land and labour. (Ibid.)

Smith then made what at first glance appears to be a very puzzling statement, and one that seems to contradict what he had said up to this point in his argument. That is, "The whole paper money of every kind which can easily circulate in any country never can exceed the value of the gold and silver, of which it supplies the place, or which (the commerce being supposed the same) would circulate there, if there was no paper money." Ibid.)

That sounds as if Smith was saying that paper money can replace gold and silver, but it cannot supplement gold and silver, that is add to the money supply. A closer reading, however, reveals that is not, in fact, what Smith was saying, although monetary theorists over the centuries have believed that Smith was saying just that, most notably David Ricardo, (David Ricardo, Minor Papers on the Currency Question. Baltimore, Maryland: Johns Hopkins University Press, 1932, 15.) who made it an important criticism in his "corrections" of Smith's theories. (David Ricardo, The Principles of Political Economy and Taxation. London: J. M. Dent and Sons, Ltd., 1992, 239-241.)

Smith first stated that the amount of paper can never exceed the value of the gold and silver that it replaces. This statement, in and of itself, is false — as Smith himself explained later. It is very easy to "over issue" paper money; Smith complained that poorly run banks were doing it all the time:

Had every particular banking company always understood and attended to its own particular interest, the circulation never could have been overstocked with paper money. But every particular banking company has not always understood or attended to its own particular interest, and the circulation has frequently been overstocked with paper money. . . . The Scotch banks, in consequence of an excess of the same kind, were all obliged to employ constantly agents at London to collect money for them, at an expense which was seldom below one and a half or two per cent. . . . Even those Scotch banks which never distinguished themselves by their extreme imprudence, were sometimes obliged to employ this ruinous resource. (The Wealth of Nations, op. cit., II.ii)

No, Smith did not mean that it is impossible to issue more paper money than there is gold or silver in an economy. He meant that it is not safe to do so. Even that, however, is not the point he was making. The key to what Smith was talking about is in the second half of the sentence, that the amount of paper money cannot — to be safe — exceed the amount of gold and silver it replaces or (and this is the important point) would have been there, the commerce being supposed the same.

In other words, the "safe" amount of paper money is not dictated by the existing gold and silver, or even the gold and silver that used to be there but was melted, exported, or hoarded. On the contrary, the amount of paper money that an economy can safely absorb without harm is determined by the amount of gold and silver that would have been there to serve the same amount of commerce.

That is, ceteris paribus ("all things being equal"), the amount of currency of whatever material is determined by the demand for financially feasible capital in the economy (the needs of commerce), not the other way around. What Adam Smith was actually saying is that an economy need never have had any gold or silver at all, and can safely use paper or anything else, as long as the amount does not exceed the actual demand in the economy for money to finance capital formation. Richard Hildreth agreed (as have numberless subsequent authorities):

It is now well understood, that the currency of any country, whether it be coin or bank-notes, cannot be increased beyond the mercantile wants of that country, without producing a depreciation in the parts which compose the currency. The total value of the currency of a country, — business being supposed to remain the same — will always be a fixed and settled amount; and if the coins or notes which compose that currency be increased, and if there is no outlet by exportation, it follows, that the value of all the separate coins and notes composing that currency, will diminish in a just proportion, so that altogether they may make up exactly the same sum total as before. (Richard Hildreth, The History of Banks. Boston: Hilliard, Gray & Company, 1837, 17-18.)

What happens if the amount of paper money exceeds the demands of commerce? According to Smith, that is when gold and silver become necessary. If no excess paper is ever issued, of course, gold and silver (or the lack thereof) need ever become a matter for concern, as Smith demonstrated. If, however, excess paper money is issued, the paper currency will depreciate in terms of gold and silver. This will cause people to hurry to exchange their paper notes for gold and silver, reducing the excess paper and thereby reestablishing parity of paper with gold and silver. (The Wealth of Nations, op. cit., II.ii.)

Gold and silver are necessary to stabilize the parity of paper money. (Ibid.) This is because bankers cannot be trusted always to restrain themselves and limit the issue of paper money to the actual needs of the economy. (Ibid.) Were it not for that, the advantages of paper would far outweigh using gold and silver in an advanced economy with a sound banking system.

Many people are surprised to discover that Adam Smith was not advocating capitalism (he never even used the word, nor did he ever mention capitalists). Capitalism, a system where the ownership of productive assets (i.e., capital) is concentrated in a few hands, was actually an alien concept to Smith. He simply assumed that whoever wanted to acquire capital could use his labor to generate income, reduce his consumption, and finance the acquisition of capital out of past savings generated by labor. (Ibid.)

In Smith's analysis, the real bills doctrine was applied to monetizing the present value of existing inventories of marketable goods and services, not to the present value of future goods and services. In his assumption regarding the financing of capital, he was wrong — but it does not detract from the validity of his observations concerning the issue of paper money. To his analysis, we only have to add that in all cases there must be real value behind the money, whatever it is made of, and the amount of new money cannot exceed the present value of all existing or future marketable goods and services in the economy, or there will be a disaster.

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Say's Law of Markets, Part II: Say's Law of Markets

So far we have discovered that, stripped of at least some of its mystique, "money" is simply the term used to describe the medium by means of which producers and consumers exchange the present value of marketable goods and services. Thus, this thing we call money is not really valuable in and of itself. Money only acquires a derived value due to the private property interest that the maker or issuer of the money has in the present value of the existing or future marketable goods and services from which the money is derived.

Say's Law of Markets

We can therefore say that we do not, strictly speaking, make our purchases with "money." Rather, we make our purchases of what others produce with what we ourselves produce by means of our labor, capital, or land. While this is clearly solidly grounded in the natural law philosophy of Aristotle (albeit with a few, easily corrected diversions along the way), it was, perhaps, most clearly expressed by Jean-Baptiste Say, a late 18th, early 19th century French political economist as his "Law of Markets."

Say was obviously not the first to state what has become known as Say's Law. Say does appear to have been the first to explain his "law" in terms that could be easily grasped . . . although subsequent economists, adhering to the incomplete definition of money and credit tied to existing accumulations of savings, have managed to misunderstand it egregiously. This has been accomplished by taking Say's Law in its truncated summarization: production equals income, therefore, supply generates its own demand, and demand, its own supply.

This usual statement of Say's Law raises more questions than it answers. We need to take Say's Law in its more complete formulation, as explained by Say to the Reverend Thomas Malthus in refutation of the latter's theories of inevitable insufficiency:

All those who, since Adam Smith, have turned their attention to Political Economy, agree that in reality we do not buy articles of consumption with money, the circulating medium with which we pay for them. We must in the first instance have bought this money itself by the sale of our produce.

To a proprietor of a mine, the silver money is a produce with which he buys what he has occasion for. To all those through whose hands this silver afterwards passes, it is only the price of the produce which they themselves have raised by means of their property in land, their capitals, or their industry. In selling them they in the first place exchange them for money, and afterwards they exchange the money for articles of consumption. It is therefore really and absolutely with their produce that they make their purchases: therefore it is impossible for them to purchase any articles whatever, to a greater amount than those they have produced, either by themselves or through the means of their capital or their land.

From these premises I have drawn a conclusion which appears to me evident, but the consequences of which appear to have alarmed you. I had said — As no one can purchase the produce of another except with his own produce, as the amount for which we can buy is equal to that which we can produce, the more we can produce the more we can purchase. From whence proceeds this other conclusion, which you refuse to admit — That if certain commodities do not sell, it is because others are not produced, and that it is the raising produce alone which opens a market for the sale of produce.

I know that this proposition has a paradoxical complexion, which creates a prejudice against it. I know that one has much greater reason to expect to be supported by vulgar prejudices, when one asserts that the cause of too much produce is because all the world is employed in raising it. — That instead of continually producing, one ought to multiply barren consumptions, and expend the old capital instead of accumulating new. This doctrine has, indeed, probability on its side; it can be supported by arguments, facts may be interpreted in its favor. But, Sir, when Copernicus and Galileo taught, for the first time, that the sun, although we see it rise every morning in the east, magnificently pass over our heads at noon, and precipitate itself towards the west in the evening, still does not move from its place, they had also universal prejudice against them, the opinions of the Ancients, and the evidence of the senses. Ought they on that account to relinquish those demonstrations which were produced by a sound judgment? I should do you an injustice to doubt your answer.

Besides, when I assert that produce opens a vent for produce; that the means of industry, whatever they may be, left to themselves, always incline themselves to those articles which are the most necessary to nations, and that these necessary articles create at the same time fresh populations, and fresh enjoyments for those populations, all probability is not against me. (Jean-Baptiste Say, Letters to Malthus. London: Sherwood, Neely, and Jones, 1821, 2-3.)

Or, to summarize to the point of near-incomprehensibility, "because production equals income, supply generates its own demand, and demand, its own supply."

Understanding Say's Law

Obviously, this explanation of Say's Law is utterly baffling to anyone who is convinced that only existing accumulations of savings can be used to finance new capital formation. From the point of view that takes the "slavery of past savings" as a given, Say's Law posits an impossible solution to the problem of an economic downturn. If, as the "slaves of savings" assume, existing accumulations of unconsumed production are the sole source of money — and thus accumulations of money (savings) — then the act of saving is restricted to those who are free (at least in part) from the necessity of consuming all that they produce simply to exist in a manner befitting the demands of human dignity.

The assumption of past savings thereby leads to the conclusion that ownership of the means of production must be concentrated, either in the hands of a private elite, or the State. This dovetails very neatly into the belief that only the State has the ability to "create" money by issuing what amounts to official purchase orders backed by the State's power to confiscate wealth in the future, whether directly by taxation, or indirectly through inflation. This is incorrect, as we will see when we look at the real bills doctrine, an application of Say's Law.

Say's Law and the "Invisible Hand"

One flaw — omission, rather — that we do find in Say's extended explanation of the Law of Markets is that he assumed as a given that if someone wants to produce a marketable good or service, this can be done equally well by means of labor, capital, or land. This, however, is a significant departure from the analysis of Adam Smith. This is incorrect on two counts. One, Adam Smith assumed as a given that human labor was and would remain the predominant factor of production. Thus (as we shall see), ownership of the means of production was a matter of indifference to Smith. Two, Say did not acknowledge that there might be barriers preventing someone from owning capital or land — a significant lacuna at a time when capital was taking over as the predominant factor of production.

In consequence, economic growth and development were slowed to a rate far below what should have been the case in an economy with an advancing technology and a frontier (the New World) open to colonization and exploitation. Despite the rising recognition and respect for personal sovereignty and individual human dignity that were creating a new political environment freed from the distortions of individualism and collectivism, erroneous ideas of money and credit ensured that, however well in theory personal sovereignty and human dignity might be recognized and respected, economic (and thus political) practice ensured a very different reality. Without effective access to the means of acquiring and possessing the means of production, most people would remain dependent on the rich for their subsistence. Disruptions in civil society were bound to — and did — become increasingly frequent and more violent as time went on, culminating in the French Revolution, which resulted in the formation of the modern Nation-State.

The Primacy of Labor Dethroned

Still, regardless of how productive capital might become and how it was financed, as long as the primary input to production was human labor, things could not be distorted too much. Until capital was able to take over the bulk of the production of marketable goods and services, it didn't matter how much wealth someone owned, or how inordinate his or her desires.

As long as labor was the predominant means of production, the rich could only satisfy their wants and needs by purchasing the labor of those who did not own capital. This made the poor dependent on the rich, true, but it also forced the rich to trade some of their wealth for the productions of the poor. As Adam Smith was to point out in his study of moral philosophy, The Theory of Moral Sentiments (1759),

The rich only select from the heap what is most precious and agreeable. They consume little more than the poor, and in spite of their natural selfishness and rapacity, though they mean only their own conveniency, though the sole end which they propose from the labours of all the thousands whom they employ, by the gratification of their own vain and insatiable desires, they divide with the poor the produce of all their improvements. They are led by an invisible hand to make nearly the same distribution of the necessaries of life, which would have been made, had the earth been divided into equal portions among all its inhabitants, and thus without intending it, without knowing it, advance the interest of the society, and afford means to the multiplication of the species. (Adam Smith, "Of the Effect of Utility upon the Sentiment of Approbation," The Theory of Moral Sentiments. Part IV, Chapter I, §10.)

This is Adam Smith's "invisible hand" argument. He reiterated it in The Wealth of Nations (1776), although, perhaps, not as clearly as in Moral Sentiments. Smith did, however, insert a version of Say's Law of Markets:

But the annual revenue of every society is always precisely equal to the exchangeable value of the whole annual produce of its industry, or rather is precisely the same thing with that exchangeable value. As every individual, therefore, endeavours as much as he can both to employ his capital in the support of domestic industry, and so to direct that industry that its produce may be of the greatest value; every individual necessarily labours to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. (Adam Smith, "Of Restraints upon the Importation from Foreign Countries of Such Goods as can be Produced at Home," An Inquiry into the Nature and Causes of the Wealth of Nations. Book IV, Chapter II, §9.)

We see, then, that the invisible hand is a combination of two essential parts: the self-interest of the rich (or whoever is in the process of realizing effective demand) and the distribution mechanism provided by human labor. The labor of the poor serves to distribute the wealth of the rich evenly throughout society in order to satisfy the self-interested demands, wants, and needs of the wealthy:

Luxury is ever in proportion to the inequality of fortunes. If the riches of a state are equally divided there will be no luxury; for it is founded merely on the conveniences acquired by the labour of others. (Charles de Secondat, Baron de Montesquieu, The Spirit of Laws. Book VII, Chapter 1.)

Taken together, the quotes from The Wealth of Nations and The Theory of Moral Sentiments point out Adam Smith's essential flaw in assuming that the invisible hand will correct and guide the market toward a maximization of justice, respect for human dignity, and acknowledgement of personal sovereignty for anybody but the rich. That flaw is found in the premise that human labor is the sole or primary means by which people gain access to the distribution of the goods of this world. Obviously, Adam Smith and others simply assumed that when the rich have an economic want or need (a "demand" in economic terms), others will supply their labor in order to produce the desired good or service to satisfy that demand.

Say's Law v. Malthusian Doctrine

Perhaps not coincidentally, the Reverend Thomas Malthus published his discredited Essay on Population in 1798, the year following the "Last Invasion of England" and the suspension of convertibility of Bank of England notes into gold. By 1821, when Say's Letters to Malthus were translated and published in English, Malthusian doctrine had become (as Joseph Schumpeter put it) established as "economic orthodoxy" despite its obvious flaws. Malthusian doctrines, however, combined with the seemingly unshakeable fixation on existing accumulations of savings as the sole source of financing for new capital formation, had a disastrous effect on acceptance of the fact that ordinary people could and should have the opportunity to participate in the economic process, both as consumers and as producers by means of their labor as well as ownership of the means of production.

Malthus' theories received a solid trouncing by economists such as John Weyland. Weyland's thesis was that the rate of population growth is determined by the state of economic development, not (as Malthus presumed) the other way around. This has been substantiated by subsequent events and supported by such diverse authorities as Jane Jacobs (Jane Jacobs, The Economy of Cities. New York: Vintage Books, 1970, 118-119.) and R. Buckminster Fuller. (R. Buckminster Fuller, Utopia or Oblivion: The Prospects for Humanity. New York: Bantam Books, 1969, 200-201.)

In other words, the more advanced a society becomes, the lower its reproductive rate; lowering the rate of reproduction does not advance a society: "population has a natural tendency to keep within the powers of the soil to afford it subsistence in every gradation through which society passes." (John Weyland, The Principles of Population and Production as They are Affected by the Progress of Society; with a View to Moral and Political Consequences. London: Baldwin, Cradoc, and Joy, 1816, 107.) Nevertheless, as Schumpeter noted,

The teaching of Malthus' Essay became firmly entrenched in the system of the economic orthodoxy of the time in spite of the fact that it should have been, and in a sense was, recognized as fundamentally untenable or worthless by 1803 and that further reasons for so considering it were speedily forthcoming. It became the "right" view on population, just as free trade had become the "right" policy, which only ignorance or obliquity could possibly fail to accept — part and parcel of the set of eternal truth that had been observed once for all. Objectors might be lectured, if they were worthy of the effort, but they could not be taken seriously. No wonder that some people, utterly disgusted at this intolerable presumption which had so little to back it began to loathe this "science of economics" quite independently of class or party considerations — a feeling that has been an important factor in that science's fate ever after. (Schumpeter, History of Economic Analysis. New York: Oxford University Press, 1954, 581-582.)

The Malthusian idea that there could be such a thing as excess people is, even from the crudest and most materialistic approach, utter nonsense. Even a rational materialist would say that unemployed people are a wasted resource, not a drain on society, regardless of their value as human beings. Nevertheless, Malthus's theories allowed the rich to assume that the misery and degradation of the working classes was their own fault for refusing to limit their numbers. Malthusian theory gave the rich a necessary salve to their consciences, and helped justify concentrated ownership of the means of production. People continued to believe — falsely — that if people were poor, it was because 1) they lacked the discipline to save and thereby accumulate the necessary financial capital to purchase productive assets, and 2) they were incapable of restraining themselves from breeding up to and beyond their own ability to support themselves.

There was, however, a slight problem with these assumptions. The predicted shortages didn't seem to be making their scheduled appearance. The new technologies that came in with the Industrial Revolution were producing marketable goods and services in such huge quantities that the problem was finding enough buyers with disposable income to purchase the tremendous amount of output, not a surplus of demand emanating from Malthus's Imaginary Multitudes. Supply and demand were becoming increasingly out of balance, but not because there was not enough to go around. On the contrary, the world was facing the paradox of people starving in the midst of plenty, even overabundance. What was going on?

We find the answer in Say's Law of Markets, stated most simply as "production = income." Once we think about this simple equation, we realize the truth of it. Every time a "production" (i.e., a good or service) is sold, it represents income for the seller. The raw materials or supplies used by the seller to produce a good or service also resulted in income for the producer of the raw materials or seller of the supplies, and so on, down the line. Thus, everything that is sold in the aggregate generates the aggregate demand to purchase it. We can therefore expand Say's Law of Markets by saying that "supply generates its own demand, and demand its own supply."

As we have seen, however, there was still a serious question remaining. That is, under the past savings assumption, except in extraordinary circumstances ownership of all new productive technology goes to the people who are able to cut consumption and save: the rich. How, then, are people without capital supposed to acquire ownership of capital if their income from labor is already insufficient to provide a living income, much less savings in sufficient amount to purchase capital?

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Say's Law of Markets, Part I: The Medium of Exchange

The suspension of specie payments following the Last Invasion of England changed many people's understanding of money, and thus of private property and even the proper role of the State. The so-called "Last Invasion of England" (which, despite the label, took place in Wales) rapidly led to the formation of two schools of finance. Each of these had a formative influence on the new science of political economy — "economics." These were the British Banking School, and the British Currency School.

The British Banking School

The roots of the Banking School go back millennia, to the beginning of the idea of money. The most basic principle of the Banking School is the definition of money: that money is anything that can be used in settlement of a debt. That is, someone has something of value that he or she wishes to exchange for something else of value that another has. For an exchange to be legitimate, of course, both parties have to own that which they offer in exchange.

"Money" is thus, in a sense, a right of private property: the right of disposal. An owner may do as he or she wishes with what he or she owns, as long as no individual (including the owner), group, or the common good as a whole is harmed. The "right of disposal" includes making a promise to deliver existing or future marketable goods or services and allowing that promise to be circulated as "money" throughout the community as long as the maker of the promise hands over what was promised when the promise is presented for redemption.

Ordinarily, we only offer in exchange what we do not reserve for our own use, our surplus — at least of that good or service. When society is limited to very small, single family groups, everyone contributes according to his or her means, and receives according to his or her needs. That is because the basis of justice within domestic society — the family — is different from that of civil society.

The purpose of domestic society (not to be confused with the meaning of domestic society) is the procreation and rearing of children. This requires that children (and by extension, adults in a dependency status analogous to that of children, such as criminals and slaves) receive as their just due whatever is needed as part of their training to enter civil society as independent, adult "others." Withholding food, clothing, shelter or education within domestic society deprives the child or dependent of his or her just due because it is contrary to the purpose for which domestic society has been established, and is thus a violation of justice.

This is not the case in the larger society outside the family. The presumption of civil society is that full participants — citizens — have been fully trained as "independent others" by their parents or guardians and are competent to function as participants in civil society. All that civil society owes the citizen in justice is the opportunity to participate fully in the institutions of the common good.

The demand of justice shifts from the distribution on the basis of what is needed to rear children or rehabilitate slaves and criminals, to equality of opportunity, a "level playing field." This is so that the adult "independent other" can exercise his or her rights and thereby develop more fully as a human being by acquiring and developing virtue. Thus, in domestic society, someone receives according to his or her needs, while in civil society, someone receives according to his or her inputs — as long as the Four Pillars of an Economically Just Society are functioning and no emergency comes up that renders it expedient in the short term to distribute on the basis of need.

As society advances beyond single family units, then, people tend to specialize in what they do best. This allows people to contribute to the overall common good in the best way they know how, and for society to reward them according to the relative value of their contribution. The hunter concentrates on hunting, the gatherer on gathering, the spear maker on making spears, and so on. This is called "comparative advantage," and, given a free market and full participation in the economy through ownership of both labor and capital, results in wealth maximization and efficient allocation of resources. As Aristotle explained,

The technique of exchange was obviously not a practice of the earliest form of association, the household; it only came in with the large forms. Members of a single household shared all the belongings of that house, but members of different households shared many of the belongings of other houses also. Mutual need of the different goods made it essential to contribute one's share, and it is on this basis that many of the non-Greek peoples still proceed, i.e., by exchange: they exchange one class of useful goods for another — for example they take and give wine for corn and so on. (The Politics, I.ix.)

Thus, even though there may be one individual in a group who is good at everything, even to the point of being better at all jobs than everyone else, it is better for that individual to concentrate on doing what he or she does best of all, and letting others specialize in the other areas — even if their best is not as good as the exemplary individual's worst.

This is because one, a single individual cannot do everything and meet all the needs of the community single-handed, and two, if a single individual produces everything for the group, the others either have nothing to offer that individual in exchange, or become dependents of that individual, thereby failing to develop more fully as persons. Under ordinary circumstances and for the good of the social unit, then — the common good of society — each person concentrates on producing what he or she does best.

This brings up what seemed to Aristotle something of a paradox: the production of goods and services that are not put to their proper use by the producer, but are used by the producer to exchange for what others produce. Each party to the transaction gains something that he or she puts to its "proper" use, while at the same time getting rid of "surplus" production resulting from specialization. As Aristotle explained,

Every piece of property has a double use; both uses are uses of the thing itself, but they are not similar uses; for one is the proper use of the article in question, the other is not. For example a shoe may be used either to put on your foot or to offer in exchange. Both are uses of the shoe; for even he that gives a shoe to someone who requires a shoe, and receives in exchange coins or food, is making use of the shoe as a shoe, but not the use proper to it, for a shoe is not expressly made for purposes of exchange. The same is the case with other pieces of property; the technique of exchange can be applied to all of them, and its origin in a state of affairs often to be found in nature, namely, men having too much of this and not enough of that. It was essential that the exchange should be carried on far enough to satisfy the needs of the parties. So clearly trade is not a natural way of getting goods. (The Politics, I.ix.)

We disagree with Aristotle that trade — exchange — is not a natural or proper way of getting goods. He may have been blinded by his enculturated contempt for productive work as opposed to leisure work, the work of civilization. As far as Aristotle was concerned, labor performed for productive purposes, that is, to provide for one's material needs, was base and suitable only for slaves. The idea that productive work could be ennobling and be a means of acquiring and developing virtue was at that time limited to Jews and, later, Christians.

As the Philosopher himself pointed out, however, the acquisition and development of virtue — "the good life" — requires the exercise of the rights of private property. (The Politics, I.iv.) One of the rights of private property is the right of disposal, of which exchange is as legitimate a choice as anything else, especially if the goal is to obtain whatever else is necessary to free one from material wants and needs in order to pursue the acquisition and development of virtue. Consistent with Aristotle's belief that different people have expertise in different areas, specialization allows society to benefit to the maximum through the functioning of comparative advantage — which requires exchange as a socially "natural" means of getting goods.

The Idea of Money

Nevertheless, Aristotle did not view exchange per se as contrary to nature. He viewed simple barter as a means of re-establishing nature's own equilibrium of self-sufficiency. (The Politics, I.ix.) It was only an exchange involving money that Aristotle considered as contrary to nature. He evidently failed to realize that, understanding money as anything that can be used in settlement of a debt, even barter involves "money"; money as a symbol of the present value of existing and future marketable goods and services is simply a more convenient way of exchanging those same goods — barter "writ large," as it were. Understood properly, all exchanges are barter. Aristotle, unfortunately, restricted his definition of money to currency, i.e., "coined money," obscuring what was actually happening in an exchange:

It was out of it [i.e., barter] that money-making arose, predictably enough — for as soon as the import of necessities and the export of surplus goods began to facilitate the satisfaction of needs beyond national frontiers, men inevitably resorted to the use of coined money. Not all the things that we naturally need are easily carried; and so for purposes of exchange men entered into an agreement to give to each other and accept from each other some commodity, itself useful for the business of living and also easily handled, such as iron, silver, and the like. The amounts were at first determined by size and weight, but eventually the pieces of metal were stamped. This did away with the necessity of measuring since the stamp was put on as an indication of the amount. (The Politics, I.ix.)

This is, more or less, how numismatic historians believe coinage developed. Aristotle's error — to recur almost continually in later centuries until finally congealed into a dogma in the tenets of the British Currency School — was to limit the idea of money to currency.

This was somewhat excusable, as coined money by Aristotle's day had been around for three or four centuries, and had largely displaced earlier forms of money such as bills of exchange and other negotiable instruments. The very convenience of coin and its ability to circulate as general purchasing power made it much more inconvenient to draw bills on the present value of existing and future marketable goods and services and use the bills as money.

Reliance on coined money also led to the illusion that all money has to be based on existing accumulations of savings. Coins can only be struck once the precious metal out of which they are made has been mined and refined. Supplies of metal — savings — have to be accumulated before money can be used either for consumption or investment — if we limit "money" to coin. If the coinage is debased, that is, less metal is put into a coin than is stated on the face, all that means is that existing accumulations of savings are being divided into increasingly smaller portions. The price level rises accordingly and each piece of money purchases less value of goods and services than before.

Viewing coined money or other State-authorized or issued currency as somehow substantially different from all other forms of money was thus, in effect, a great leap backwards. One, as we noted, it led to the idea that State authorization is essential to something being regarded as "money"; that nothing else can possibly be money. This is a change in the substantial nature of what takes place in an exchange, from being based necessarily on someone's private property in what is being exchanged, to a redistribution by the State of what ostensibly belongs to private individuals. Private property is, in effect, abolished. As John Locke pointed out, "For what property have I in that which another may by right take, when he pleases to himself?" (John Locke, Second Treatise of Government, § 140.)

Two, viewing coined money and other State-authorized or issued currency as the only true money led to the disastrous and erroneous belief that new capital formation can only be financed by cutting consumption, accumulating, and then forming the capital. To all intents and purposes this restricts ownership of all new capital to those who had the ability to accumulate: the rich. It doesn't matter that any first year accounting student could point out the basic fallacy of this belief — retained earnings (savings) are not charged for capital investment — it became accepted economic and financial dogma. This was despite the fact that there was no evidence that finance was actually carried out in this manner once society advanced beyond reliance on human labor and simple technology as the predominant factors of production. (Vide Harold G. Moulton, The Formation of Capital. Arlington, Virginia: Economic Justice Media, 2010.)

Finally, and perhaps most fatally, the belief that only coined money or its State-authorized substitutes can be money ignores reality. It may seem a small thing today, when so many basic institutions of society are destroyed or redefined seemingly on a whim, but the claim that reality can be so changed is a profound shift in our perception of reality, and thus what it means to be human.

The Idea of Credit

Clearly, the development of coined money was in many respects an important advance. Misused or not properly understood, however, it managed to become a drag on economic and social development. This was, in large measure, the result of viewing coined money, and later forms of money, such as banknotes and demand deposits, as the only "real" money, or a substitute for "real" money, respectively. Consequently, everything except coined money was considered either not real money at all, or a derivative of real money, i.e., coined money.

The problem is that by restricting our understanding of "real" money to coined money, and considering banknotes and demand deposits as derivatives of "real" money, and all forms of credit as similarly derived, is completely backwards. The fact is that "money" and "credit" are two different terms for the same thing. As Henry Dunning Macleod explained, "Money and Credit are essentially of the same nature; Money being only the highest and most general form of Credit." (Henry Dunning Macleod, The Theory of Credit. Longmans, Green and Co., 1894, 82.)

The fact is that what we think of as "credit" preceded coined money by hundreds, if not thousands of years. Bills of exchange and promissory notes — negotiable credit instruments — were common in both ancient Mesopotamia and Egypt, as the vast amount of material in the form of clay and papyrus documentation makes abundantly clear. Such credit instruments are derivatives of the present value of existing and future marketable goods and services.

Credit instruments can take any form to which the parties to a transaction agree and which thereby constitutes a contract. This can be a verbal agreement supported solely by a promise maker's reputation — his or her creditworthiness — a clay tablet specifying the terms of the contract, a sheet of papyrus, parchment, or paper, or a generalized certification stamped on a lump of metal by some recognized authority.

Money as a Derivative of Production

To be legitimate, that is, to constitute a valid contract or promise, the maker of the promise — the issuer of the "money" — has to have the power to make a promise. Because the matter of a contract deals with the deliverability of marketable goods and services, the maker of the promise has to own that which he or she promises to deliver. A contract is therefore a derivative of the present value of existing or future marketable goods or services.

A bill of exchange or a promissory note is thus a derivative of existing or future production of marketable goods and services. Drawing a bill or issuing a promissory note is creating a promise — a debt — while redeeming the bill or making good on the note is settling the debt. Because a bill or a note has a present value, it can itself be used to settle a debt, and circulate as money until presented by the holder in due course for redemption by the issuer.

Early bills of exchange and promissory notes were usually denominated in terms of commodities, e.g., so many head of cattle or so much weight of metal. When Abraham purchased the field of Ephron with its twin caves as a burial ground, he paid not in coin, but in weighed silver, as was the custom before the invention of coinage: "He [Abraham] weighed out the money that Ephron had asked, in the hearing of the children of Heth, four hundred sicles of silver, of common current money." (Genesis 23:16.)

Obviously having to weigh out metal every time someone wished to engage in a transaction was both time consuming and complex. Someone eventually had the brilliant idea that a large weight of metal, e.g., a talent, could be broken up into smaller pieces, e.g., drachma, pre-weighed and stamped with a certification to save time and effort. Similarly, a few thousand years later someone would realize that a bill of exchange or promissory note, instruments usually denominated in very large amounts, could be treated the same way. The smallest denomination of a bill of exchange that would be accepted by the United States Federal Reserve System when it was first established in 1913, for example, was $100,000, the standard denomination at the time for commercial paper, the usual term for short-term bills of exchange.

Obviously, bills of exchange would be too cumbersome for everyday transactions under ordinary circumstances.  There have been exceptions, such as the County of Lancashire in England in the late 18th and early 19th century, when bills of exchange in small denominations circulated more readily than banknotes, and during the Great Depression when personal checks, bank drafts, and similar instruments filled in for a dearth of legal tender currency. Ordinarily, however, besides being typically issued in large denominations, bills of exchange have to be indorsed ("endorse" — traditionally, "indorse" is the spelling used for financial instruments, but "endorse" is not incorrect) by each holder in due course until presented to the issuer for redemption.

Commercial banking was invented as a way of "breaking up" commercial paper into smaller pieces called banknotes: small denomination promissory notes backed by the general credit of the issuing bank and secured by the commercial paper, that would be acceptable in daily transactions wherever the bank's credit was trusted. Turning commercial paper or other bills of exchange into banknotes is called "discounting" and "rediscounting," a term also applied when the bill itself is used as money directly.

The term "discount" comes from the practice of using a bill as money or exchanging it for a different form of money (e.g., coin, demand deposits, or banknotes) but at less than the face value of the instrument. For example, commercial paper with a face value of $100,000 may be offered in settlement of a debt of $98,000, meaning that the bill is discounted at 2%. When a holder in due course uses the bill to settle a debt in turn, it may be "rediscounted," say, at 1% and pass at $99,000, depending on how much time is left before maturity.


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Say's Law of Markets: Prelude

It was February 22, 1797, "the Last Invasion of England." Panic spread throughout England when a small French force commanded by Colonel William Tate landed in Wales at Carregwastad Head near the village of Fishguard (Abergwaun). This was a diversionary maneuver in support of Theobald Wolfe Tone's abortive rising in Ireland.

Yes, 1066 is the date all school children learn as the date of the last successful invasion of England. This, of course, ignores the incursion by Henry Tudor in 1485 that culminated in the Battle of Market Bosworth and the fall of the Plantagenet dynasty. It also tends to downplay or ignore the fact that England was constantly threatened by enemies, both foreign and domestic, as it left the more integrated society of the Middle Ages behind and struggled between individualism and collectivism as the Nation-State system evolved.

The Rise of the Nation-State

Nor, despite popular myth, was England an isolated case. The basic conflict, however, was probably more sharply delineated in England than anywhere else. This was possibly because the struggle was confined in a much smaller area, with less interaction with other participants on the European stage, at least within England itself. This was not, however, the extreme isolation that many historians have posited; the British Isles were never completely outside the "family of Europe." The Channel only delayed participation of the "Three Kingdoms" in the Thirty Years War until after the official termination of hostilities with the Treaty of Westphalia in 1648.

The Treaty of Westphalia only succeeded in shifting the titanic struggle for the future of civilization to the east and to the west of Central Europe. The moment open hostilities ceased in the German States, the "Deluge" began in the Polish-Lithuanian Commonwealth to the east, and the Civil Wars and the Great Rebellion convulsed the British Isles to the west. Ultimately, the older, more integrated and increasingly personalist civilization of Medieval Europe went down before the elitist "new things" of the modern age: individualism and collectivism. The most significant "new thing" was the shift in the basis and understanding of right and wrong — the natural moral law — from the Intellect (Nature, discerned by reason), to the Will: opinion backed up with the coercive power of the State.

As both Mortimer Adler and Heinrich Rommen pointed out, changing the basis of the natural law from Intellect to Will laid the foundation of the modern totalitarian State lauded by John Maynard Keynes: might makes right. Not surprisingly, we find the philosophy of the absolutist Nation-State detailed in the work of Thomas Hobbes, notably Leviathan, written in support of the "divine right" monarchy of the Stuarts, particularly in Hobbes's assertion that the divine right sovereign is the ultimate owner of everything in the country.

With even less surprise we discover that the parliamentarians who temporarily overthrew the Stuart monarchy, replacing it with the Commonwealth, did not differ substantially in their basic philosophy of government — or in their approach to political economy. As Walter Bagehot was to analyze the situation in The English Constitution (1867), as England entered the modern age, power shifted not from an elite back to the people, but from a hereditary, aristocratic elite that controlled the land, to a commercial elite that controlled the new technologies. In a development that took centuries, ordinary people were, by and large, stripped of any significant ownership or control of the means of production, and increasingly forced to rely exclusively on wages for the whole of their income.

This was the culmination of a process that had begun under Henry VII Tudor. Under the Tudor dynasty, the common people rapidly lost what little political and economic power they had slowly gained over the centuries. It was with the rise of the "new men" and their commercial and financial power that small farmers were forced off the land to concentrate the resources of the country on wool production, "the Staple." This called forth the satiric observation by Thomas More in Utopia to the effect that in England, instead of the normal arrangement in which men ate sheep, the sheep were eating men.

The Glorious Revolution and the Bank of England

Even the "Glorious Revolution" of 1688 was not a triumph of personalism over elitism, but a temporary victory of libertarianism over collectivism. For most people, the change meant little or nothing; it was simply a commercial instead of hereditary elite that seized power. Ownership of the means of production, whether land or technology — and thus power — remained concentrated.

True, given a choice between libertarianism and collectivism, the rational individual will tend to favor libertarianism. Libertarianism recognizes that human beings have rights by the mere fact that they are human, thus making them "natural persons." A libertarian would have little, if any objection to the natural law-based "Four Pillars of an Economically Just Society," although he or she might be confused by the correlative demand that the exercise of natural rights is necessarily constrained within a strict juridical order — no one may exercise his or her rights in any way that harms the right holder, other individuals, groups, or the common good as a whole. The Four Pillars of an Economically Just Society thus can be taken as a brief statement of the essential elements that we must find in a well-run society:

• A limited economic role for the State,

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

• Recognition and protection of the rights of private property, especially in the means of production (and today, especially, in corporate equity), and — the "fatal omission" from all major schools of economics,

• Widespread direct ownership of the means of production.

This is not, of course, to say that libertarianism is an acceptable philosophy, only that it is less objectionable than collectivism. In general, the libertarian philosophy does not recognize barriers that exist to full participation in the common good, that is, to the full and carefully defined exercise of natural rights by every member of society. In other words, there is a deficient understanding in libertarianism of man as a political animal.

Thus, when the Bank of England was formed in 1694 as a means of accommodating commercial interests in the City of London by discounting and rediscounting bills of exchange, it was, in a sense, the high-water mark of individualism in Europe. It was the last significant move to assert the rights of private property — or any other natural right — as independent of the State, albeit in a truncated way, that is, without full recognition of man's political nature. The State might regulate, define, or otherwise standardize the medium of exchange, but it could in no wise be said to create it.

The problem was that, in order to secure the necessary royal charter, the Bank of England had to agree to loan the State virtually the whole of its capitalization in the form of gold coin and bullion. The capitalization of the Bank was thereby transformed from precious metal, into pieces of paper that the State certified as being as good as gold — but without actually having the gold to back up the government debt paper now held by the Bank.

This move did not change the original purpose of the Bank. It did, however, minimize the commercial aspect of the Bank of England by handing over to it management of the currency. This gave the impression that the money supply did not consist of anything that could be used in settlement of a debt — and thus anything on which a bill of exchange could be drawn, i.e., the present value of existing and future marketable goods and services — but of coin, banknotes and (later) demand deposits. In other words, the understanding of "money" changed from being a symbol of what was owned, a means of conveying a private property right in existing or future marketable goods or services, to itself being a marketable good or service — a commodity.

This was a serious and, ultimately, fatal inroad on private property, and a consequent victory for collectivism. Money is not simply a State-certified token or purchase order. Rather, money is a means of conveying a claim on existing or future marketable goods and services in which the issuer of the money has a private property right. When the issuer of a currency does not have a private property right in what backs the currency, private property has been violated to that extent: theft. By backing the currency by its own "faith and credit" — which translates into the ability to collect taxes in the future out of wealth belonging to its citizens — the State erodes the institution of private property throughout society.

The Last, Great Hope of Mankind

In light of the great victory that collectivism had achieved over both libertarianism and personalism by redefining money, the success of the American Revolution takes on an even greater significance. Superficially a triumph of individualism, the American Revolution was, in reality, a rebirth of an ideal that — while it had never reached full realization — was more consistent with human nature than mere individualism.

As originally conceived America was as close as the human race has ever come to a realization of humanity's political nature, that is, a creature with individual rights within a social context. Had it not been for human chattel slavery, the new government of the United States, still the only government in the world that specifically acknowledges sovereignty of the individual, would have (in human terms) been as close to the ideal of an economically and politically just society as could be achieved. This was chronicled in such diverse works as Alexis de Tocqueville's Democracy in America and William Cobbett's The Emigrant's Guide. The link between Catholic social teaching as formulated in the social doctrine of Pope Pius XI and de Tocqueville's observations of 1830s America has yet to be properly explored.

In America, the above-noted "Four Pillars of an Economically Just Society, the essential elements of an economically just society were all present for what may have been the first time in history. While obvious from a natural law point of view, these Pillars have often been derailed or sidelined by circumstances. More often, however, the Four Pillars are marginalized or ignored due to a lack of sophistication about the institutions of money and credit. This is crucial, because money and credit in whatever form they manifest themselves in society are the chief means by which people acquire and maintain ownership of the means of production.

Admittedly, lack of widespread understanding about money and credit was not a problem that was solved in America so much as sidestepped. The chief means of production up until the latter half of the 19th century was the same in America as it had been throughout the world for millennia: land. In America it was much easier to acquire a piece of land than anywhere else in the world. This accelerated with the passage of Abraham Lincoln's 1862 Homestead Act, laying the foundation for the immense commercial and industrial expansion that the United States experienced during the latter half of the 19th century.

The Great Shift

With the closing of the land frontier to all intents and purposes in the 1890s, even the United States became susceptible to the swings in the business cycle caused by misuse of money and credit and the lack of widespread ownership of the means of production. The predominant means of production was shifting rapidly from land and labor, to capital — but the ownership of the new industrial technologies was highly concentrated. Concentration of ownership became greater and greater in the twentieth century, until the Great Depression put an end to widespread small ownership. The middle class changed from being small land owners and proprietors of small shops and manufactories, often almost completely family run, to wage earners, dependent on the wage and welfare system to make ends meet.

This changed the whole character of American society. Before the Great Depression, people who subsisted on wages alone were, by and large, viewed as "the working poor." Whatever degree of affluence the middle class enjoyed came largely out of small ownership. With the shift that occurred with the Great Depression and the tendency under Keynesian economics for the financial system as well as the State to favor highly concentrated ownership of large industries and combinations (reaching its height in the "conglomerate fever" of the 1970s), wages and employer paid fixed benefits and pensions became the road to presumed financial security for most people.

Ownership of the means of production, previously virtually the sole road to comfort, even affluence, became an alien concept for most people. People began looking more and more to the State to make up for the failure of the free market to provide adequately for people's material needs. Under the pressure of the Keynesian economic hegemony and its utter reliance on existing accumulations of savings as the only source of financing for new capital formation, non-productive consumer credit and government debt assumed larger and rapidly expanding roles as the driving force behind economic growth, or even to sustain current levels. The bubble may finally have burst with the current "Great Recession."

The English Situation

Today's "Great Recession," however, was still more than two centuries in the future in 1797. The Industrial Revolution had not yet made it to America in any significant degree, but it was starting to have its effect in England. Napoleon Bonaparte might sneer at England as "a nation of shopkeepers," but even he could not deny that the commercial and industrial might of the British Empire presented the only real threat to his plan of conquest. Even the retreat from Moscow in 1812 would have been a setback, albeit major, from which "the Man of Destiny" would quickly have recovered had not the English been there to back up the Allies. Even so, the speed with which Napoleon was able to assemble yet another Grand Army after his escape from Elba demonstrates the level of financial and commercial resources necessary to stop him — which only the English at that time had.

That is not to say that the British did not cripple their own war effort almost fatally from the beginning by mismanagement of the money and credit system, and by working (almost as if by plan) to keep most people out of ownership. There was no land frontier in the British Isles to provide opportunities for ownership of productive assets, and the financial system virtually guaranteed that ownership of both the land and the new industrial capital would be highly concentrated. All it needed was a trigger for the financial and political powers-that-be to seize control of the money power in England, already highly concentrated as a result of the virtual hijacking of the Bank of England a century previously.

That trigger was provided by "the Last Invasion of England," which we noted at the beginning of this posting. There wasn't all that much to it. On February 22, 1797 a force of between 1,200 and 1,400 French soldiers were landed from a flotilla of four small ships at Carregwastad Head near the village of Fishguard in Wales. The first landing spot selected was "near Bristol," where the French Commander, the elderly Irish-American Colonel William Tate, was to land his force, composed mostly of sweepings from various French jails, many of which were probably still uncertain as to which end of a musket to point at an enemy.

The plan was to take and burn Bristol, then cross into Wales and march against Chester and Liverpool. How this was supposed to be accomplished by a force of at most 1,400 ill-equipped and poorly trained recruits wasn't exactly clear. Weather conditions were unfavorable for a landing near Bristol, so Colonel Tate decided to go straight to Wales, setting course for Cardigan Bay. When the French warships arrived at Fishguard Bay, a signal gun from the local fort fired to warn the townspeople was mistaken for possible resistance, so Tate, elderly but not stupid, circled around to Carregwastad Head as the landing point, rather than let his ragtag troops be caught with their feet wet and slaughtered while attempting to land.

The troops and supplies were unloaded and on Thursday morning, February 23rd, the French ships sailed away to report a successful landing — their departure possibly hastened by the distant sighting of a large number of women in traditional Welsh garb come out to see the strange sight, mistaken in the light of dawn for red-coated British soldiers. The British captured two of the French vessels, a frigate and a corvette (a vessel smaller than a frigate), and the other two French warships returned home.

The French soldiers almost immediately set about looting and were unfortunate enough to be successful, the local folk having "liberated" a large quantity of wine and food from a Portuguese merchantman that had run aground recently. There were a few shots fired, but apparently most of the French were too drunk to fight effectively (or at all), and surrendered on Saturday (some sources say Friday) to the local militia led by Lord Cawdor.

The somewhat farcical nature of the "invasion" is illustrated by the epic of "Jemima Fawr," or "Jemima the Great," revered in somewhat tongue-in-cheek fashion as a great heroine in local legend. Jemima Nicholas, a 47-year old housewife and wife of the town cobbler, single-handedly captured a dozen of the invaders sober enough to walk under their own power. Although armed only with a pitchfork, Jemima the Great brought them into town, locked them up, and went out looking for more victims.

The Run on the Bank

While mildly amusing to read about, and evidently not taken too seriously by the local Welsh men and women, the effect was otherwise throughout England to the east. People rushed to convert their Bank of England banknotes into gold and withdraw all of their savings (in gold, of course) just in case the diversionary raid in Wales turned out to be the opening shots in a full-fledged invasion.

Gold reserves dropped so low that Sir William Pitt's government permitted (or ordered, depending on your source) the Bank of England temporarily to suspend convertibility of its banknotes into gold. This temporary measure lasted for more than two decades. Convertibility of the paper pound into gold was not restored until 1821.

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