Thursday, May 26, 2016

How Capital Is Not Limited

This past Tuesday we looked at the claim that financial capital is necessarily finite, and that new capital formation is necessarily limited by the amount of existing savings in the system.  After examining the nature of money and credit, we concluded that this assumption — that Louis O. Kelso and Mortimer J. Adler called “the slavery of savings” — is not merely misleading, it is completely wrong.  Existing savings are not the only source of financing for new capital formation.
The State as a "Mortall God"
Yesterday we examined why capital is not finite.  We concluded that because financial capital (money and credit) is just a system of promises, if people can make promises — enter into contracts — they can “create” all the money they need to carry out exchange.  You don’t need the permission of an all-powerful State to engage in trade and commerce.  All you have to do is be productive and have the capacity to enter into contracts.
Today we’re going to look at how capital is not finite, that is, we’re going to outline the basic principles of a rational financial system based on sound precepts of the natural law — meaning common sense.  So, clear your mind of all you think you know about Say’s Law, money and credit, banking, finance, and production.  If you don’t, you’re in for a bumpy ride.
We start with the basic principle that the purpose of production is consumption.  We then take as a given that it is impossible to consume what has not been produced.  Consequently — all things being equal — the only way to consume is to produce.
If you want to consume, then, you must either produce for your own consumption, or to exchange what you produce for what others produce that you wish to consume.
In classical economics, there are three factors of production: labor, land, and technology.  The first we call the human factor of production.  The latter two we call the non-human factor of technology or “capital.”
As technology advances, "labor" must own technology.
As capital advances, labor’s contribution becomes smaller.  Obviously, then, as capital takes over more and more of the share of production, it becomes essential that people own capital as well as labor.
For example, when people were hunters and gatherers, they needed a huge amount of land to be able to find enough food on which to survive.  When weapons were invented, less land was needed as more animals could be killed without as much trouble.  When crops began to be grown, even less land was needed . . . but each family had to have enough land to grow the crops, or it wouldn’t have enough to eat.  The same happened with tool-making and the production of goods and services other than food.  The more efficient capital becomes, the more essential it is that people own capital, whether land or technology.
Land is easy to obtain.  You can occupy vacant land, purchase occupied land, or just push the others off.  Technology, however, has to be constructed.  You don’t find it just lying around.  You are therefore limited to making it yourself, trading for technology that someone else has made, or stealing it.
Smiths were sacred because they made tools.
The first is impractical for most people.  We simply don’t have the expertise to manufacture our own tools.  That’s why in many ancient societies the smith was considered sacred.  He made the tools that allowed people to produce or steal wealth.
The problem is that as all the land gets taken, and technology advances, it becomes increasingly expensive to purchase it.  Most people simply don’t have what it takes to be able to save enough to purchase capital.
The solution that Louis Kelso developed was for people to purchase capital that pays for itself out of its own future profits.  Instead of cutting consumption to save and then purchase capital, you first purchase capital, increase production, and then save.
The promise to pay tomorrow for what you purchase today can be embodied in a contract, and the contract can be used as money to purchase the capital.  The only requirement is that all the parties to the contract are reasonably assured that everyone keeps all the promises that were made.  In this way capital can pay for itself without the new owner first having to save.
We’ll get into some of the technicalities of this on Monday.

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