Thursday, June 16, 2011

Economic Recovery, Part VIII: The Formation of Capital (3)

They can't say we didn't warn them. The only difference between what we and the (other) doomsayers predicted about Greece's and the other PIIGS's current meltdown is that we do not believe it was inevitable. It was only inevitable within the flawed economic and financial paradigm now afflicting the world. The newspapers (taking the Washington Post and the Wall Street Journal as "the newspapers") are full of the dangers inherent in the latest Greek disturbances, both economic and civil: "Greek Debt Crisis Nears a Tipping Point," Washington Post, 06/16/11, A1; "Stocks Tumble on News from Greece, Rise in U.S. Prices," ibid., A16; "Fresh Greek Shock Waves," Wall Street Journal, 06/16/11, A1; "French Banks Warned on Their Greek Debt," ibid., A14; "Greek Scare Spills Into U.S.," ibid., C1; and, of course, all the stories that have a tie-in.

The basic scenario, of course, remains unchanged: people are demanding that the government continue to fund its current programs at an acceptable level, maintain current levels of employment, and create new jobs to take care of the increasing numbers of unemployed. The problem, of course, is that the tax base won't — or can't — support even current spending, and governments' ability to mortgage future tax revenues is eroding rapidly throughout the world. People are refusing to face the fact that you can't consume what you can't afford today, and pay for it tomorrow forever, if only because if you can't afford what you consume today, what makes you think you will be able to pay tomorrow for what you consume today and tomorrow?

Keynes thought he had the answer: in the long run we're all dead. Yeah — but others will still be living (or trying to), and they are the ones who are going to have to pay for what we consumed today and meet their own needs on top of that.

The fact is, if we go into debt for consumption, we're sticking the next generation with the bill for our dinner, the old "dine and dash" that forces low income waitresses to pay for our meal. If we go into debt to finance new capital formation . . . we're rich (okay, affluent, but "rich" sounds better), and, potentially, without sticking anyone. The way things are being run, the debts we incur for today's consumption are being passed on to tomorrow's children — at least those we permit to be born, and they won't be able to pay, any more than Greece is able to pay now for yesterday's consumption. Somebody has to foot the bill for all those dishes you throw around and break at a dinner party, and it should be the ones who break them.

The problem is that a number of very bad assumptions have combined to create an even worse situation. One, the assumption that the only way to finance new capital formation is to cut consumption and save. Two, the assumption that human labor is the only thing truly productive, and wages the only way for most people to obtain income (related to "one") — the "labor theory of value." Three, the government can and should do anything and everything better than private citizens, especially control the financial system . . . for its own benefit. After all, four, if the government wasn't in debt, there would be no backing for the money, right?

Wrong. The ideas that the government can do everything better, and should be in charge of the financial system are two of the most damaging assumptions of all. We could probably go on forever believing that all those bills of exchange aren't money and new capital isn't financed on credit. So long as the economy keeps running using bills of exchange as money, who cares whether we believe it or not? Any first year accounting student should have learned enough to realize that most capital isn't really financed out of savings (retained earnings). You don't charge retained earnings for new capital investment. No, you charge an asset account, or increase a liability account. And this concerns you . . . how? Do you really know how your automobile works, or that electric light? Do you care?

We can also go on believing in the labor theory of value, and that the return to the owner of capital instruments is theft of surplus value from the worker and the consumer. As long as the capitalist is forced to pay an adequate wage to his or her workers, and the government taxes capital income to distribute welfare to the unemployed or those who can't work, things can keep going. Many people were astonished when businesses were able to show tremendous profits during World War II when the highest corporate tax rate reached 95%, and the highest personal rate reached 94%. Nor was this dependent on government deficits for war spending, at least according to Keynes. He actually protested using debt to finance the war in his book, How to Pay for the War (1940). This system eventually breaks down, but, given an otherwise sound economy and otherwise limited government, things can go on for some time. It's socialism, but even socialism can keep going for a while if the government limits itself to forcing the private sector to pay for government mandates directly, stays out of debt, and doesn't manipulate the financial system or inflate the currency. It's unjust, and contrary to human nature, but it can work . . . for a while.

No, it's those last two assumptions that are the killers. One of Ronald Reagan's favorite jokes was, "The nine most terrifying words in the English language are, 'I'm from the government, and I'm here to help." Unfortunately, it's not that funny. While many people today are demanding the closing down of the Federal Reserve and the vesting of the "money power" in the federal government "where the Constitution puts it" (no, it doesn't), they don't seem to understand that the federal government already controls the money power — the independence of the Federal Reserve is a legal fiction, and will remain such as long as the Federal Reserve deals in government securities, primary or secondary, purchased by discounting or in open market operations. It is government control of the central bank, and the fixed belief that without an outstanding national debt you won't have a money supply, not the income tax, that has permitted the incredible growth of government since 1916, and has put even the United States into a terrifyingly shaky financial situation.

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