Wednesday, September 7, 2011

Capital Day, Part II: Labor Alone is Insufficient

As we saw in yesterday's posting, the Panic of 1893 not only precipitated the Great Depression of 1893-1898, but the Pullman Strike of 1894 and thus Labor Day. The Panic itself was made much worse by the fact that by 1893 and the "official" closing of the land frontier, a determinant number of people in the United States had wages not as their primary, but sole source of income. When jobs began disappearing in the wake of the economic downturn, many people were left destitute. Those who retained jobs faced wage cuts in many cases. This was the direct cause of the Pullman Strike, and led to the inauguration of Labor Day to celebrate the worker.

Labor Day did not, however, do anything to "create jobs" or raise wages. It was a sop to pacify the labor movement. Neither did the federal government give in to pressure to inflate the currency to fund the building of new infrastructure. It had taken decades to restore faith in the currency and restore parity with gold. This was particularly important in view of the fact that following the Civil War the United States had become a major participant in the global market. As a direct result of the war, America's chief export had shifted from slave-cultivated cotton on large plantations, to wheat grown on the relatively small holdings made available by Lincoln's 1862 Homestead Act.

Especially at that time, international trade required that participants have stable and elastic currencies that are not manipulated by governments. Communications were barely adequate to keeping people abreast of natural changes in prices and demand. Had currency manipulation à la Keynes been the order of the day, utter chaos would have reigned in the global economy as each country tried to use Keynesian monetary sleight-of-hand to gain an edge on the competition. Only the virtually instantaneous communications we enjoy today make such a system in any degree sustainable, and — as the increasing fluctuations in the stock markets of the world reveal — the system is starting to implode under the increasing strain of governments trying to have their respective cakes and eat them, too.

As it was, the United States had a stable currency, but under the National Bank system (the quasi-central bank established by Treasury Secretary Salmon P. Chase in 1863) the currency was inelastic, that is, fixed in quantity. Paradoxically, from the point of view of the ruling Currency Principle, while the currency was inelastic, and thus hurt the consumer and the small farmer, artisan and wage worker, the primary money supply — bills of exchange discounted between businesses and at the National Banks — was elastic, expanding and shrinking directly with the needs of the productive sector.

Thus, a contributing factor to the severity of the Great Depression of 1893-1898 was that productive capacity had grossly outstripped effective demand. This was because productive capacity — derived from consumer demand — was financed by expanded bank credit through discounting and rediscounting bills of exchange. Consumer demand, however, was realized primarily through small transactions carried out using the fixed National Bank Note currency, supplemented with the Treasury Notes of 1890, silver and gold certificates, and, in last place, gold and silver coin and a token bronze and copper-nickel minor coinage. When the diversion of what should be consumption income to reinvestment is added to the decreasing relative contribution of human labor to production (direct contribution, that is; ultimately, and traced to the original source, it all comes from labor somewhere down the line — indirectly), wages alone are not enough to provide individuals and families with an income sufficient to meet ordinary domestic needs adequately.

So how have people survived? In our day, at least since 1950 and the introduction of widespread use of easy consumer credit with the institution of the "Diner's Club" card, a fix in the disconnect between supply and demand has been jury-rigged by consumers' new power to create money virtually at will by drawing small bills of exchange at the point of purchase with a credit card. Previously, under the New Deal, the effort was made to increase effective demand by inflating the currency by having the government emit bills of credit and redistribute existing wealth through the tax system.

Both methods are still in use, and both are ultimately disastrous, albeit in different ways. Using consumer credit cards more or less matches the money supply to existing inventories of marketable goods and services. This takes up the slack in consumer demand caused by reinvestment of earnings to finance new capital formation. (Actually, by the retention of earnings in businesses in the form of added investment to provide collateral for new capital investment, but the bottom line is the presumably essential reduction in consumption, which is what we're looking at.)

The credit card method of increasing effective demand, as long as users do not exceed the present value of anticipated future income in the short-run (and actually receive that income), can function adequately as a substitute for an elastic, asset-backed currency, and is relatively stable . . . in the short-run. It does, however, cause widespread individual distress in the mid- to long-run as the burden of personal debt increases dramatically in an ongoing effort to equalize the system artificially and circumvent Say's Law of Markets and the problems caused by rejecting the real bills doctrine.

As a case in point, consider the current situation. At present, the per capita non-mortgage revolving debt in the United States is roughly $10,000. If we assume a "typical" family of four and a median income of $50,000, then the average American family has "pre-spent" approximately 80% ($40K) of its future annual income. When penalties and interest are added, and combined with the tax burden (both income taxes and FICA — cir. 20% or so effective tax rate on married filing jointly on $50K, or $10K), the average American family is paying out more each year than it is taking in. Even in a "normal" economy, the American family is slowly being strangled by debt.

Is the answer subsidized job creation and increasing pay and benefits? No. Job creation and wage and benefit increases without corresponding increases in production are simply reflected in a rising price level. The worker is hit with a double whammy because wages almost always lag behind a rise in the general price level as manufacturers and retailers try to keep ahead of the game. They do this by raising prices before actual costs go up.

This is the Keynesian system of "forced savings." The effect is to transfer wealth from consumers to producers via an inflated currency and rising prices. Aggregate consumer spending increases in dollar terms, but, paradoxically, per capita real consumption declines. Since the demand for capital goods is derived from actual consumer demand, not redistribution through inflation or the tax system, the demand for new capital formation (and thus job creation) stalls — the Keynesian "liquidity trap."

The Keynesian liquidity trap is a self-caused phenomenon resulting from an apparently adequate supply of investment funds and rising consumption spending, but decreasing actual consumption. There is thus no real incentive to finance new capital formation and job creation. Harold Moulton called this paradox "the economic dilemma." (Harold G. Moulton, The Formation of Capital. Washington, DC: The Brookings Institution, 1935, 26-36.)

Inflating the currency by emitting bills of credit and redistributing existing wealth through the tax system is less immediately disastrous to individuals and families. Eventually, however, such an increase in the power of the State seriously erodes the independence of the family by making individuals and families increasingly dependent on the State for virtually everything. As one clueless commentator declared, "The State is the sole intercessor available to the poor"! (Dr. Rupert J. Ederer, "Solidaristic Economics," Fidelity magazine, July 1994, 9-15.)

In the interim, however, and before the inevitable collapse, the State finances its power-grab by drastically increasing the public debt and debauching the currency. Per Keynesian doctrine, this should not be a problem. The size of the public debt isn't something that need concern us. As Alvin Harvey Hansen, "the American Keynes" (Keynes's chief prophet in the United States), declared, "the debt should cause no anxiety so long as it is kept within safe limits." (Fortune magazine, November 1942, p. 175, quoted by Harold G. Moulton, The New Philosophy of Public Debt. Washington, DC: The Brookings Institution, 1943, 66.)

And what, exactly, are the parameters of those "safe limits"? According to Mr. Hansen as reported by Moulton, "the debt might safely be double the national income." (Moulton, ibid.) Translation: the outstanding public debt, that is, total government obligations, can be twice GDP without any danger. Note that this is only public debt, and does not include private sector debt.

What does this mean? According to the World Bank, the GDP for the United States was roughly $14.6 trillion for 2010 . . . the calculation was revised earlier this year from 2006 on so that the government would look better and the growing army of unemployed wouldn't be quite so scared. According to Mr. Hansen, that means the national debt can safely rise to nearly $30 trillion without giving anyone anything to worry about.

Is that, however, really the case? Let's take a look.

As of 10:00 am today (EDST), according to the "National Debt Clock" the outstanding public debt of the United States was just a little short of $14.7 trillion. This is well within the declared Keynesian safety parameters, at least according to the man largely responsible for committing America to the Keynesian paradigm.

Obviously something is out of whack. The public debt is nowhere near the Keynesian "safe limit," and yet the U.S. economy is very close to imploding. Producers are not investing in new capital, and thus the rate of "natural" job creation appears to be negative, i.e., jobs are disappearing as a cost-cutting measure, in competition with advancing technology, and as jobs are shifted to lower wage countries. Nor can consumer or government spending take up the slack for the decrease in effective demand. Both consumers and the government are, as the above statistics reveal, tapped out. Additional debt will only cause additional problems.

What, then, is the answer?


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