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.
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| 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)
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| 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.
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| 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.
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| 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.
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| 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.
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| 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.