Keynesians continue to insist, in the face of all evidence to the contrary, that the debt crisis is really nothing to worry about. As a feature article in the Washington Post business section gushingly enthused a few months ago in its over-lengthy title, "It's Not as Bad as It looks. Worried About the Growing Deficit? [Yes, that was printed in red ink in the original.] Modern Monetary Theorists Say It's No Trouble, and in Fact It's Key to a Vibrant Economy." (February 19, 2012, G1, G4.) How this belief can be sustained in the face of reality is baffling, especially once we realize the true nature of money and credit, banking, and finance.
We start with the assumption that the purpose of economic activity — the production of marketable goods and services — is consumption. If we do not intend to consume something ourselves, or trade it to another for what he or she has produced and that we want to consume, we have no reason to produce it. All economic activity can therefore be summed up as "the purpose of production is consumption."
This is the basis of "money." (Credit is simply money in a different form.) Money is the medium through which we exchange what we produce for what others produce — the "medium of exchange." More simply put, money is anything that can be accepted in settlement of a debt. Money, as Louis Kelso noted, is not itself the thing of value, but a symbol of the thing of value, a way of measuring it, storing it, and conveying a private property stake in the thing among persons.
Thus, we do not really purchase what others produce with this thing called money. What we are really doing is exchanging what we produce for what others produce, using the abstraction known as money to make the process easier. This is "Say's Law of Markets," that we cannot purchase what others produce to a greater degree than what we have produced; that to consume, we must produce. This can be oversimplified somewhat by saying production equals income, therefore demand (income) generates its own supply (production), and supply, its own demand.
Say's Law assumes at least two things as given, however. One, there is nothing preventing someone from producing marketable goods and services with either labor or capital. If you need labor to produce something, nothing stops you from laboring with all your might. If you need capital, nothing prevents you from either building (forming) the capital, or purchasing it from someone else who has built it.
Two, if you need to purchase capital, nothing prevents you from entering into a contract, offering that contract to whoever has what you need, and having the contract accepted in payment of the debt incurred at the present value of the marketable goods and services you expect to produce in the future with the capital you are purchasing.
This is the "real bills doctrine." Contracts entered into that are based on the ability of the one offering the contract to make good on the contract at a specified time are called "bills of exchange." The ability to make good on a contract is called "creditworthiness." The one offering a contract doesn't have to have what is needed to meet the obligation at the time he or she offers the contract. He or she only has to have what is needed to meet the obligation at the specified time.
Thus, if someone buys a field and promises to pay for the field with half the value of the annual crop yield every year for thirty years, he or she doesn't have to have half the value of each crop now. He or she only has to have it at harvest time, and then only in the agreed-upon increments.
Obviously this can get more complicated. For example, the seller wants the full purchase price now. The buyer and the seller agree on the estimated present value of thirty years' worth of half yields, and strike a bargain. If the buyer hasn't saved up enough cash, he or she goes to a commercial bank and offers a contract to the bank giving half the yield over thirty years to the bank. The bank accepts the contract, and issues a promissory note.
This promissory note can be used to back other promissory notes called "banknotes," or a demand deposit — a checking account. The borrower takes the banknotes or demand deposit and hands over the agreed upon purchase price to the seller. At harvest time, the borrower gives the bank half the value of the annual yield, canceling the debt after thirty years. Thus, the real bills doctrine is that there can always be enough money to go around and people will be able to purchase capital if they can offer contracts for the present value of a future stream of income realized from the production of marketable goods and services.
Of course, if anything interferes with people being able to produce by means of their labor or their capital, then Say's Law will not operate, and thus the real bills doctrine cannot be applied. Obviously, then, there must be three principles to ensure the just functioning of the market so that Say's Law will operate. We can call these the principles of economic justice: Participation, Distribution and Harmony.
The principle of Participation is that every person has the natural right to participate in the production of marketable goods and services by means of both labor and capital. As technology advances and capital takes over more and more of the burden of production, it becomes critical, as Louis Kelso observed, that people formerly dependent on their labor for income become owners of capital.
The principle of Distribution is that every person has the natural right to receive the results of production in proportion to his or her inputs. For example, if someone participates in production by contributing 10% of the inputs to production, he or she should receive 10% of the profits, or bear 10% of the losses.
The principle of Harmony is that when the system is flawed and people are unable to participate in production or receive a distribution commensurate with their inputs, the system must be restored to operate fairly once again.