Wednesday, August 3, 2011

The Binary Bridge of Asses, Part II

As we saw in yesterday's posting, the whole idea of "binary growth" is a little bit outside the usual frame of reference for most economists. Trapped by "the slavery of past savings," homo œconomicus cannot get his mind around the idea that it is possible to finance capital formation without first cutting consumption, that it is possible to enter into a contract today, use the contract to purchase capital tomorrow (either using the contract itself as a negotiable instrument, or discounting it at a commercial bank), and redeem the contract next week when the profits start rolling in.

Inasmuch as this is the heart of Say's Law of Markets as applied in the real bills doctrine, and the way in which most capital is financed today, slavish adherence to the past savings dogma ensures that most people will not be able to enter into contracts (i.e., "create money") without first having accumulated a store of wealth. Consequently, most people are unable to become owners of the capital that is producing the bulk of wealth in the world today, and are forced to rely on labor alone to generate income.

To review, as classically stated, Say's Law asserts that we do not actually purchase what others produce with this thing called "money." Money is just the symbol for what we are really dealing with: the present value of existing and future marketable goods and services that we produce with our labor and capital, and that we exchange for the present value of existing and future marketable goods and services that others produce with their labor and capital.

(Say put it in classical terms, of course: "land, labor, and capital," but "land" and "capital" are both productive things, so in binary economics both count as "capital.")

"Money" is thus anything that can be used to carry out a transaction, i.e., "settle a debt." It can be the actual good and service, or a piece of paper or some other medium conveying a claim redeemable with goods or services on demand or on the occurrence of some specified future event, such as a due date, peace treaty, or anything else that is reasonably expected to happen. Anybody deemed competent can enter into a contract, and, therefore, anybody deemed competent can create money.

Given the real bills doctrine (an application of Say's Law of Markets), it is possible to create money for capital investment without first cutting consumption. The only requirement is to draw up a contract conveying a property right in the present value of the stream of marketable goods and services that the capital is expected to produce. This promise can be used to purchase the capital, and redeemed when the capital produces a profit.

Currency Principle economics asserts that this is impossible, maintaining that it is essential to cut consumption before new capital can be financed. This creates what Dr. Harold G. Moulton called, "The Economic Dilemma," and which we have decided (at least for the sake of this posting) to call the true pons asinorum of economics.

The economic dilemma can be stated thus: No reasonable businessman finances new capital formation until and unless he or she has a reasonable expectation that there is sufficient effective demand for what the capital will produce. Given sufficient effective demand for the marketable goods and services to be produced by the new capital, the capital will generate enough income to recoup the original cost of the capital, and afterwards provide an adequate return to compensate for the effort expended and resources committed to the enterprise. To obtain the financing under Currency Principle assumptions, however, consumption has presumably been cut. This reduces the possibility that there will be sufficient effective demand to justify the investment in new capital. (Harold G. Moulton, The Formation of Capital. Washington, DC: The Brookings Institution, 1935, 26-36.)

Thus, the Currency Principle "economic dilemma" can be stated most simply as, "There will be no savings to finance new capital unless consumption is reduced, but if consumption is reduced to generate savings, there will be no incentive to finance new capital." Keynesian economics attempts to circumvent this dilemma by currency manipulation, "forced" saving and job creation by inflation, and "cooling off" an "overheated" economy by taxing away excess income or raising interest rates. This, as Keynes admitted in Volume I of his Treatise on Money (1930) is tantamount to Georg Friedrich Knapp's "chartalism" (The State Theory of Money, 1924),  a program of total State control of money . . . and thus effective State ownership of what money will buy.

Obviously, replacing the use of existing accumulations of savings — unconsumed production — in finance, with future savings made possible by the application of Say's Law in the real bills doctrine solves this problem. With a "supply of loanable funds" determined exclusively by and matched directly to the "supply" of financially feasible new capital projects by drawing, discounting and rediscounting bills of exchange backed by the present value of existing and future marketable goods and services, the need for currency, tax, or interest rate manipulation is eliminated . . . although the urge that politicians feel to raise funds in ways that render them unaccountable to the taxpayers will always remain.

This "Banking Principle" has the potential to eliminate those business cycles caused by unnaturally limiting demand in order to accumulate savings unnecessarily for reinvestment in new capital, or "over-saving." Consistent application of the Banking Principle would put the economy in equilibrium — but not really do anything to grow the economy once equilibrium has been reached . . . especially if the income from capital remains in few hands and the people to whom those hands are attached just cannot find enough ways to spend the income generated by the capital they own, that is, the capital they control and from which they have the right to the full stream of income generated.

Given an economy in equilibrium, income that is not spent on consumption might bid up the price of luxury goods or speculative investments ineligible for capital credit that is not linked to existing accumulations of savings — "pure credit" — but it would not increase economic growth. At the same time, however, there would be increasing unmet wants and needs among people with only their labor to sell.

Economic growth, as Jane Jacobs pointed out in The Economy of Cities (1970), usually only results from an increase in effective consumer demand. Moulton corroborated this by pointing out that the demand for capital goods is derived from consumer demand. (Moulton, The Formation of Capital, op. cit., 37-48.) Unfortunately, throughout history most people have not owned appreciable amounts of capital, whether land or artifacts, and have been limited to selling their labor to generate income.

As long as labor is the predominant form of production, this is usually bearable. Thus, while control of land — in which category of capital we include all non-artifact productive wealth — has frequently been monopolized, owners still needed great amounts of human labor to make the land productive. This provided the incentive for chattel slavery, but also, where slavery was not the rule, high wages for free labor.

Interestingly, the belief that the rich cannot satisfy even their most exorbitant wants and needs without employing the poor in order to obtain their labor led Adam Smith, the alleged "high priest of capitalism" — a system based on concentrated private ownership of capital — to declare that ownership was irrelevant! As he explained in The Theory of Moral Sentiments (1759),

"And it is well that nature imposes upon us in this manner. It is this deception which rouses and keeps in continual motion the industry of mankind. It is this which first prompted them to cultivate the ground, to build houses, to found cities and commonwealths, and to invent and improve all the sciences and arts, which ennoble and embellish human life; which have entirely changed the whole face of the globe, have turned the rude forests of nature into agreeable and fertile plains, and made the trackless and barren ocean a new fund of subsistence, and the great high road of communication to the different nations of the earth. The earth by these labours of mankind has been obliged to redouble her natural fertility, and to maintain a greater multitude of inhabitants. It is to no purpose, that the proud and unfeeling landlord views his extensive fields, and without a thought for the wants of his brethren, in imagination consumes himself the whole harvest that grows upon them. The homely and vulgar proverb, that the eye is larger than the belly, never was more fully verified than with regard to him. The capacity of his stomach bears no proportion to the immensity of his desires, and will receive no more than that of the meanest peasant. The rest he is obliged to distribute among those, who prepare, in the nicest manner, that little which he himself makes use of, among those who fit up the palace in which this little is to be consumed, among those who provide and keep in order all the different baubles and trinkets, which are employed in the œconomy of greatness; all of whom thus derive from his luxury and caprice, that share of the necessaries of life, which they would in vain have expected from his humanity or his justice. The produce of the soil maintains at all times nearly that number of inhabitants which it is capable of maintaining. 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, be 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. When Providence divided the earth among a few lordly masters, it neither forgot nor abandoned those who seemed to have been left out in the partition. These last too enjoy their share of all that it produces. In what constitutes the real happiness of human life, they are in no respect inferior to those who would seem so much above them. In ease of body and peace of mind, all the different ranks of life are nearly upon a level, and the beggar, who suns himself by the side of the highway, possesses that security which kings are fighting for." (IV.I.10.)

The problem with Smith's "invisible hand" argument (presented in The Theory of Moral Sentiments and reiterated in The Wealth of Nations, 1776), is that Smith failed to realize the effects of advancing technology. Technology has been replacing labor in the production process at an accelerating rate ever since the start of the Industrial Revolution.

Consequently, the effective demand available to most people has been reduced, both in objective terms and relative to what goes to the owners of capital. To try and bring the economy back into balance and make up for the reductions in effective consumer demand, governments have engaged in wage manipulation and redistribution, increases in government debt, and joined with the private sector in making consumer credit increasingly available on easy terms until it becomes obvious that the burden is too great to be repaid, and the system starts to implode, as it has in our day.

The solution, as Louis Kelso saw it, is to supplement or in some cases replace wage income entirely with capital income, adding widespread capital ownership to Moulton's prescription of "production and employment" as the sustainable remedy to an economic downturn (Harold G. Moulton, The Recovery Problem in the United States. Washington, DC: The Brookings Institution, 1936, 114). The more widespread ownership of capital becomes, the more effective demand will be realized. This would provide incentives for economic growth as living standards rise and previously unmet wants and needs are satisfied. As Moulton explained,

"It is an obvious truth that the needs and desires of an expanding population constitute potential markets for the sale of goods and services. But it is equally true that the unfulfilled wants and desires of the existing population constitute potential markets. If the economic system is operated so as to expand consuming power in proportion to the increase in productive power, there is no reason why a slowly increasing, or stationary, population should check industrial expansion. And so long as a large proportion of our population is 'ill-housed, ill-clothed, and ill-fed,' it is not difficult to determine the kinds of additional production which the population most needs." (Harold G. Moulton, The New Philosophy of Public Debt. Washington, DC: The Brookings Institution, 1943, 24.)

Putting together Say's Law and the real bills doctrine, with the increase in effective demand realized by spreading out ownership of the new capital financed by applying these "pure credit" principles, we come up with the principle of "binary growth." This concept holds that economies grow steadily larger as private capital acquisition is distributed more broadly among the population on market principles. This concept also focuses on the importance of unleashing the unutilized or underutilized capacity of all economic systems to produce in greater abundance to satisfy previously unfulfilled wants and needs.

Thus, in an extremely limited sense, what binary economics does is correct the flaws in Ricardo's Law of Rent by making "free land," that is, "free capital" in all forms available to people without savings or the ability to cut consumption — but only if by "free" we mean that we do not use existing accumulations of savings to finance investment, but "future savings" to achieve the same end.

Nothing is truly "free" in the binary growth model, of course, unless we count freedom of association, a natural right, that empowers us to enter into contracts, thereby creating the money we need to finance new capital formation without first reducing consumption. To someone trapped within the Currency Principle of the slavery of past savings, however, the use of future savings can indeed create the illusion that the capital is being acquired without cost to the owner: "free."

This, however, is only an illusion. All capital is paid for, and paid for with savings. It's just a question of when the saving takes place: before or after the capital is formed. That is the key that Say's Law and the real bills doctrine offer to unlock the "secret" of binary growth.

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