According to today's Wall Street Journal, the European Central Bank is "betting big" on stimulus, i.e., print enough money, and Something Good will happen. Add to that all the uproar over the Federal Reserve recently, and we decided to start taking a look at money and credit. In The Formation of Capital (Harold G. Moulton, The Formation of Capital, Washington, D.C.: The Brookings Institution, 1935), Dr. Harold G. Moulton, president of the Brookings Institution, presented the theoretical foundation for the monetary reforms advocated under Capital Homesteading. Moulton pointed out that economic growth does not depend exclusively on past (accumulated) savings. There need not be a tradeoff between expanded consumption and expanded investment.
|Dr. Harold G. Moulton|
Moulton pointed out that demand for capital goods is a derived demand. In other words, demand for capital is derived from the demand for consumer goods, and that the latter depends on consumption incomes.
Interestingly enough, Paul Samuelson supported Moulton’s insight. In a footnote in his leading textbook on Keynesian economics, Samuelson stated,
“We shall later see that, sometimes in our modern monetary economy, the more people try to save, the less capital goods are produced; and paradoxically, that the more people spend on consumption, the greater the incentive for businessmen to build new factories and equipment.” [emphasis in original] (Paul A. Samuelson, Economics: Sixth Edition. New York: McGraw-Hill, 1964, 47n)
Moulton pointed out that forcing people to reduce their consumption to purchase new capital assets is counter-productive. It reduces the viability of all investment, which ultimately depends on consumer demand. He then posed the question, “Where could funds be procured for capital purposes if consumption was expanding and savings declining?”
Moulton answered his own question:
“From commercial bank credit expansion. Such expansion relieves the possibility of shortage in the 'money market' and enables business enterprises to assemble the labor and materials necessary for the construction of additional plant and equipment.” (Moulton, The Formation of Capital, op. cit., 107)
|Dr. John Maynard Keynes|
Most economists assert there can be no growth without savings, and there can be no savings unless, as Keynes asserted, we cut back on consumption. As Keynes declared, without offering any evidence or argument to support his contention, “So far as I know, everyone is agreed that saving means the excess of income over expenditures on consumption.” (John Maynard Keynes, General Theory of Employment, Interest, and Money (1936), II.6.ii.)
Keynes repeated this assertion in § II.7.i of his General Theory. Having made that statement, however, Keynes then contradicted himself by saying that all the people who disagreed with this definition of saving (whom Keynes had just declared did not exist), were in error! (Ibid., II.7.iv.)
Keynes’s fundamental error was to limit “money” to contracts representing only the present value of existing marketable goods and services, i.e., mortgages, and to ignore all contracts representing the present value of future marketable goods and services, i.e., bills of exchange. Keynes construed bills of credit, a special form of bill of exchange emitted by a government, as multiplying claims on existing marketable goods and services instead of promises to remit wealth out of future tax collections.
|Unused plant capacity.|
Moulton argued, however, that the real limits to expanded bank credit were physical ones. These include unexploited technology, unused capital resources and raw materials, an unemployed or underemployed work force, unused plant capacity, and ready markets for new capital goods and new consumer goods.
Moulton’s study of one of the fastest growth periods of U.S. economic history, 1865 to 1895, revealed a surprising fact. While bank reserve requirements remained relatively constant, and the paper currency was deflated to restore parity with gold (a goal achieved relatively early, in the late 1870s), the money supply expanded greatly through the expansion of commercial bank credit, offsetting the deflation of the paper currency.
At the same time, and despite the tremendous expansion of the money supply in the form of merchants and bankers acceptances (bills of exchange), price levels declined for the period by about 65%. (Moulton, The Formation of Capital, op. cit., 87, 116.) Moulton also demonstrated that even in periods of great business activity, productive energies are normally under-used; there is always some slack in the system. He proved there can be rapid growth and expansion of the money supply without inflation.
|Inflation and depression.|
On the other hand, we can have rising prices alongside recession, as we experienced in the “stagflation” of 1974. Explaining this paradox, Moulton’s conclusion is worth noting:
[T]he expansion of capital occurs only when the output of consumption goods is also expanding; and . . . this is made possible by the [simultaneous] expansion of credit for production purposes. (Moulton, The Formation of Capital, op.cit., 118.)
Thus, as long as the increase in the present value of existing and future marketable goods and services keeps pace with the expansion of the money supply, there will be no inflation. In fact, if actual production exceeds the rate of new money creation, the currency will appreciate, that is, increase in value, as the price level drops in response to the increase in supply over the increase in demand, and each unit of currency can purchase more goods and services — a phenomenon that some authorities mistake for deflation of the currency.
|How economists and policymakers take everyone for a ride.|
Another error made by traditional economists and policymakers is to confuse cause and effect. Assuming that monetizing anticipated future increases in production provides the financing for new capital formation, the effect of an increase in the present value of existing and future marketable goods and services — things transferred in commerce — is an increase in the money supply.
Trapped by the assumption that new capital formation can only be financed by past decreases in consumption, however, traditional economists and policymakers assume that the noted increase in the money supply is the cause, not an effect, of the increase in production. They thereby 1) mistake inflation as an indication of economic growth, 2) justify inflating the currency by increasing government debt, and 3) confuse the great good of currency appreciation with the evils of deflation.
|Money must link production and consumption directly.|
Understanding the true nature of money and credit as “anything that can be used to satisfy a debt” (“all things transferred in commerce”), Moulton did not fall into the past savings trap and draw these erroneous conclusions. He was fully aware that if all new money creation is linked directly to the increase in the present value of existing and future marketable goods and services through private sector mortgages and bills of exchange, respectively, there would be a direct, private property link between the money supply, and what money will buy. There would be neither inflation nor deflation.
Unfortunately, however, in making the connection between expanded bank credit and expanded capital creation, Moulton did not take the next logical step. He failed to realize that expanding the base of capital ownership, and thus capital income distribution, could serve as a more direct and more efficient source of mass purchasing power to absorb future increases in production of final consumption goods.
Fortunately, as we will see tomorrow, Louis Kelso picked up where Moulton left off.