Wednesday, March 11, 2015

Past Savings and Pure Credit

The stock market is booming (except for that eentsy little drop yesterday ... good for the short sellers) ... but why does the economy seem so bad away from Wall Street?  It might be because a critical tenet of Louis O. Kelso’s binary economics is that the purpose of production is consumption. Within the logic of the Kelsonian economic system, all income (particularly income produced by capital), should be spent for consumption, instead of saving it for reinvestment and using it to increase capital gains (which traditionally have been accorded more favorable tax treatment than dividends).

Louis O. Kelso
This makes sense.  The feasibility of investment, after all, depends on consumption sufficient to buy the goods and services produced by the investment. Hence, where there is a more effective way for financing new capital formation, it makes no sense to force people to reduce their consumption incomes to buy capital. It weakens the feasibility of private sector investments by draining off cash needed to repay the capital acquisition loans.

This means that corporate profits, after being used to pay off capital acquisition loans, should be paid out to owners as consumption incomes instead of being used for capital growth. The formation of new capital, under Kelso’s system, should be financed with additional pure credit loans monetized by the central bank, while corporate profits could be used to sustain or even increase consumer demand, thus improving the market picture for the entire private sector.

The Bank of North America, the first U.S. central bank.
“Where will the money come from?” That may be the most common question asked by those encountering the Kelsonian model for the first time. To answer that question, it is important to understand why we need this thing we call “money” in the first place.

As we’ve explained before, money is anything that can be accepted in settlement of a debt.  When we understand that, we realize that money is just a symbol of things people exchange — that’s why money is sometimes defined as “the medium of exchange.”

That is not a mystic formula.  All it means is that money is what we call it when I trade what I have, for what you have.  All money is a contract, just as (in a sense) all contracts are money.

Adam Smith
Ordinarily, the only way to consume something is to have something, and the only way to have something is to produce something.  That is why Adam Smith built his entire economic theory on one principle: “Consumption is the sole end and purpose of all production.” (Adam Smith, The Wealth of Nations (1776), III.viii.)

Thus, we can only consume if we produce something to consume ourselves, or if we produce something to trade to somebody else for what he or she produced.  We can either trade things directly (barter), or by means of a contract in which we promise to deliver things to the bearer of the contract at some future time (a bill or note).

We can even make contracts of a standard and stable value so that other people can use them to carry out exchanges until we redeem the contract (currency).  Finally, we don’t have to have the things on hand when we make the contract, only when the contract is presented to us for redemption.

For example, assume we have a plan to produce something.  We don’t have the thing yet, but we are reasonably certain we could produce it in, say, three months . . . if we had the money to buy what we need to produce it.

An early start saving for the future.
We can, of course, go to work for somebody else for a wage, and accumulate savings by not spending (consuming) all the money we are paid.  That takes a long time, however, and we would probably miss the opportunity to produce the thing we want to produce.

We also have the option of finding someone who already has savings, and is willing to lend us the money to produce the thing.  The problem there, of course, is that someone lending out of an existing accumulation usually wants to own our project, take most of the income, or both.

A final option is to promise to pay people in the future for what they supply to us now.  In this way, we can obtain what we need to produce something, market it at a profit, and use some of the profits to pay the debt.  If nobody knows us enough to trust our contracts, we take a contract to a commercial bank, which everyone trusts, and trade our contract for the bank’s contract (at a fee, of course), and repay the bank the money we borrowed.

In this way, anybody with a feasible project can finance new capital, put it into production, and repay the loan of money without first having to accumulate savings.  We can replace past savings, with future savings.  The only question is not where the money is to come from, but where the opportunity to produce something is to come from.

That’s the real question Kelso answered, and it’s very simple — although we’ll wait until tomorrow to look at Kelso’s answer.


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