Monday, November 16, 2015

Do We Need the Rich?


Last Monday we posted a (much edited) response of ours to a student asking for help on an economics question.  That is, we posted our response to the student’s first question.  There was another, which we will proceed to post (and answer) today:

Do we need the "Idle Rich"
“Critically discuss the following statement by presenting either three (3) arguments for it or three (3) arguments against it: ‘The rich are not indispensable to the stability and survival of any society.  Rather, the rich are ultimately a net cost to any society.’”

Critically discussing the actual question first, we give three arguments against the statement itself:

1. As shown, it’s coherent.  More or less.  We had to edit it, however, as the original was nearly incomprehensible.  The teacher evidently needs to take a remedial course in test-giving.

2. It’s not one statement, it’s two: One, the rich are unnecessary, and, two, the rich are a cost to society.  By putting the two together, the teacher was asking a “complex question,” which presupposes the answer to a question that hasn’t been asked, e.g., the classic example, “Are you still beating your wife?”

3. Even as edited, what the teacher wanted is, strictly speaking, unclear.  Did he or she want a critical discussion of the statement (which these three points are), or of the issue . . . however badly stated . . .?

Now we can discuss the issue instead of the statement:

Kelso: consumers must produce, producers must consume.
To begin, the Just Third Way is, in part, an application of the “Banking Principle” found today only in the binary economics of Louis O. Kelso and Mortimer J. Adler.  This is in contrast to the “Currency Principle” that underpins the Keynesian, Monetarist/Chicago, and Austrian schools of economics.

We won’t get into the Currency Principle since it is based on certain false assumptions, as has been demonstrated on this blog many times.  At the heart of the Banking Principle, however, is the fact that we don’t need the rich to finance new capital formation.

Adam Smith
In fact, past savings (existing accumulations of wealth) are the worst thing to use to finance new capital.  Past savings represent unconsumed production.  Diverting past savings away from consumption and to production distorts the economic equation.  As Adam Smith pointed out in The Wealth of Nations, “Consumption is the sole end and purpose of all production.”  Not saving, not production intended for non-consumption, consumerism, or waste, not anything else, but consumption.

To finance new capital using “future savings” it is only necessary to have a feasible capital project ready to start building.  The present value of the project can be put into contract form (a “bill of exchange”) and either used directly as money to finance the new capital formation, or taken to a bank and discounted, using newly created bank promissory notes as money, whether in the form of banknotes (rare these days) or demand deposits (“checking accounts”).  To make things less risky and ensure a uniform, stable, and elastic asset-backed reserve currency, a central bank can be set up to rediscount such qualified paper, with the central bank’s promissory notes substituted for or backing the commercial bank’s promissory notes.

In other words, all that is necessary to finance new capital formation without the rich is feasible capital projects that can pay for themselves out of their own future earnings, and a banking system to provide media of exchange that are recognized as uniform and stable.

So, to present three arguments in support of an amended statement (the rich are not ultimately a net cost to any society — the idea is socialist), we can go to Harold G. Moulton’s The Formation of Capital (1935) and Kelso and Adler’s The New Capitalists (1961).  We’ve included a link to the e-version of The New Capitalists (lousy and inaccurate title, by the way).

1. “Money” is anything that can be accepted in settlement of a debt (“All things transferred in commerce” — Black’s Law Dictionary).  That being the case, both past decreases in consumption (past savings) and future increases in production (future savings) can be used as money if embodied in a contract (called a “mortgage” when the contract represents past decreases in consumption and a “bill of exchange” when the contract represents future increases in production).  Since anyone can have a feasible project to increase production in the future, and the present value of the future increase in production can be turned into money to finance the capital that will increase production, it is unnecessary to rely on past decreases in consumption — by definition a monopoly of the rich — to finance new capital, and the rich are not necessary to an economy.

Why not capital credit insurance?
2.  Collateral is wealth that secures a lender against the risk that a borrower will default on a loan.  While, strictly speaking, collateral is not essential to be able to make or obtain a loan, no rational lender will make a loan unless it can be adequately collateralized.  The problem is that traditional collateral is in the form of existing wealth, and existing wealth is by definition a monopoly of the rich.  This limits the ability to borrow for new capital formation to the rich.  There is, however, another way to secure against the risk of default: insurance.  By replacing traditional collateral in the form of existing wealth with a “capital credit insurance” (or reinsurance) policy, and using the “risk premium” charged on all loans anyway as a premium on the policy, anybody can collateralize a capital project.  The rich are not necessary in order to provide collateral.

The rich can benefit society by spending their money to increase demand.
3.  The demand for new capital is derived from consumer demand.  If people cut consumption to save (or, the same thing, do not consume all their income), demand falls, and production falls in response, all things being equal.  Yet no rational person of his or her own free will finances new capital unless there is demand to justify it; consumer demand leads (although in practical terms increases in consumer demand and new capital formation are concurrent phenomena).  This is what Moulton called “the economic dilemma”: cut consumption to save in order to finance new capital formation, and demand falls and there is no reason to finance new capital formation!  The answer, of course, is to finance out of future savings based on future increases in production, not past savings based on past decreases in consumption . . . but what about the accumulated savings of the rich?  They “harm” society by not spending all their income; they should be encouraged to spend, thereby benefiting society by increasing demand and thus increasing opportunities for new capital formation and a wider distribution of capital ownership.  Inheritance laws should be altered to encourage breaking up accumulations instead of maintaining them, e.g., tax the heirs instead of the estate, and allow everyone to accumulate assets on a tax-deferred basis up to a level of capital self-sufficiency, e.g., $1 million.

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