The claim that both capitalism and socialism are based on opinion — faith — is easily proved. As we have demonstrated countless times on this blog, both capitalism and socialism rely on the demonstrably false premise that the only way to finance new capital formation is to cut consumption and accumulate money savings; financing for all new capital is presumed to come out of the present value of production that was withheld from consumption.
On the contrary, as anyone who knows the first principle of commercial banking is aware, the financing for new capital formation may, in fact, come from the present value of past cuts in consumption, but that is not necessarily the case. Neither, as Dr. Harold G. Moulton and others have proved, is it the better way.
Very much the contrary, as a matter of fact. As Moulton demonstrated in The Formation of Capital (1935), reducing consumption (withholding production from consumption) in order to finance new capital formation harms the financial feasibility of the new capital the investor intends to finance. It can even, when the investor realizes that there is insufficient consumer demand to justify the new capital formation, prevent the new capital from being formed in the first place.
Given that, as Adam Smith said, the sole purpose of production is consumption, we reasonably conclude that it is contrary to the purpose of production to withhold production from consumption in order to finance new capital to increase production. More simply put, if we are not consuming all that is being produced now, of what conceivable use is it to increase production?
That is the “economic dilemma” (as Moulton put it) facing the “capitalist,” or (in socialism) the State if it takes over control of the economy. He or she knows full well that new capital investment must take place if economic activity is to be sustained. At the same time, the individual investor cannot justify financing the formation of additional new capital when there is clearly insufficient demand for what existing capital is already producing.
It is, to all appearances, a perfect “Catch-22” situation. If the capitalist invests in new capital when there is no demand for what the capital will produce, he or she will go bankrupt. If, on the other hand, there is a demand for all that is being produced and more besides, there is little or no possibility of withholding anything from consumption to use in financing new capital formation. The capitalist goes out of business. (That is a reductio ad absurdum, of course, but it illustrates the basic problem.)
Past savings — the present value of past cuts in consumption — are not, however, the only or even the best source of financing for new capital formation. There is also “future savings,” that is, the present value of future increases in production. Just as derivatives (“money”) called mortgages can be created using the present value of existing marketable goods and services as the “underlying,” that is, as the asset backing the derivative, derivatives called bills of exchange can be created using the present value of future marketable goods and services as the underlying.
Believing — erroneously — that past savings are the only source for financing of new capital formation has one of two results. If we believe that the market will take care of things without the State doing more than policing abuses, enforcing contracts, and in general providing a level playing field, we end up with capitalism. Ownership of capital must be concentrated in the hands of a private sector elite, for only people whose capital produces far more than they can consume can afford to finance the formation of new capital, thereby providing jobs for the rest of us.
If, however, we believe that the market and private initiative cannot be trusted to take care of things, and that government action is required to both regulate and control the private sector so that everyone will be taken care of adequately and there will be sufficient investment to create enough jobs (whether or not we believe State control will continue to be necessary, or it will wither away), the State must take an ever-increasing role in the economy. That is socialism.
The way to avoid the fallacies of both capitalism and socialism is to realize that new capital formation can be financed better using the present value of future increases in production — future savings — than by using the present value of past cuts in consumption: past savings. Reliance on past savings, however (despite its obvious falsity) accepted as an absolute dogma by all mainstream schools of economics, and virtually all of their offshoots. That makes it a matter of opinion, or faith, not reason.
Further, it is a very bad faith. Genuine faith does not mean accepting something you know is not true just because somebody in authority said so. Rather, faith is a “willingness to believe” — but not a “willingness” that contradicts human reason. Matters of faith may go beyond reason, but they cannot contradict reason.
Be that as it may, we are concerned here with matters of science — reason. The goodness or badness of someone’s faith is completely irrelevant to the discussion, even though the supporters of past savings as the sole source of financing for new capital formation ultimately base their position on faith. All they have done, frankly, is make a bad argument worse by asserting a non sequitur.
We have shown how this applies to capitalism. It now becomes our task to show how it applies to its twin sister, socialism. That is the subject of the next posting in this series.