Last Thursday we noted that the ability to accumulate — “save” — while an aspect of money, is only peripheral to the principal function of money, which is to be spent, i.e., “consumed.” Money, which is anything that can be accepted in settlement of a debt, derives from the functioning of Say’s Law of Markets.
|Smith: the purpose of production is consumption.|
To recap, Say’s Law, derived from Adam Smith's principle that “consumption is the sole end and purpose of production,” is that you can’t consume what hasn’t been produced. That being the case, and except for charity, theft, and redistribution by duly constituted authority as an expedient in an emergency, in order to consume, you must produce, whether for your own consumption directly, or to trade to others for what they have produced that you want to consume.
“Money” is the medium by means of which we carry out these trades or exchanges. All money is therefore a contract, just as all contracts are, in a sense, money.
Credit is implicit in the idea of money, and thus money also acts as a store of value. This allows people to put aside something for future consumption, or to accumulate the means of future consumption.
There are thus two types of money, determined by whether the money is based on something that exists right now (past savings) and can be redeemed at any time, or on something that will exist when the money becomes redeemable (future savings). Technically, past savings money is a “mortgage,” while future savings money is a “bill of exchange.”
According to financial historian Benjamin Anderson, the first principle of finance is to know the difference between a mortgage and a bill of exchange. Not knowing the difference makes for a very complicated and, frankly, screwed up economic and financial system.
This is because today’s three main schools of economic thought, Keynesian, Chicago/Monetarist, and Austrian, all take for granted the disproved assumption that the only way to finance new capital formation or even acquire existing capital is to cut consumption and accumulate money based on past savings, i.e., mortgages. In a bizarre twist, because the mainstream schools of economics do not recognize future savings money as money, even when they use future savings, they insist they are really past savings.
There are a number of serious problems associated with using past savings to finance new capital formation. We’ll look at three of the worst (if we tried to cover them all, we’d have to write a ten volume encyclopedia just for the short version).
One. Accumulating money savings before investing reduces consumer demand, thereby restricting consumption. This has a triple whammy.
|"Proletariat" is Latin for "propertyless worker."|
First, the people who most need to become capital owners are the very ones who can’t afford to cut consumption. Since the purpose of capital in production is to replace human labor with something more efficient or less costly, driving down the market value of labor, non-owning workers need to replace the income from labor with income from capital . . . but don’t have the means to purchase capital.
Second, cutting consumption in order to save to invest in new capital means that there is less reason to invest in new capital. This is because the demand for new capital derives from consumer demand. If consumer demand falls because people are saving instead of consuming, so does the demand for new capital.
Third, it throws a monkey wrench into Say’s Law. Say’s Law is based on the principle that the purpose of production is consumption. If production is diverted to reinvestment, the system goes out of balance.
Two. As technology advances and grows correspondingly more expensive, using past savings to finance new capital formation assumes the existence of a class of capitalists, necessarily small, who have the capacity to cut consumption in the required amounts. This, too, has a triple whammy.
First, since capital ownership must be restricted to as few people as possible in order to have people who can save the required amounts, most people are restricted to wages and welfare for their consumption income.
Second, depending on wages alone for income always results in “creating jobs” just to provide people with consumption income. This increases costs and raises prices to the consumer . . . which cuts demand and decreases the demand for new capital and the need for new jobs. If consumer demand falls far enough, layoffs and RIFs reduce the number of jobs.
Third, to make up for the loss of income, government begins printing money, inflating the currency, transferring purchasing power from producers to non-producers, and inflating prices even more, adding to the problem.
|Milton Friedman's Capitalist Creed: "Greed is Good."|
Three. The idea grows and spreads that “greed is good.” Why? Because in the past savings paradigm you need a very small number of people to be as rich as possible to invest as much as possible. Violating Adam Smith’s first principle of economics, the idea becomes to create as many jobs as possible regardless whether the production is needed to satisfy consumer demand.
Mere accumulation — “greed” — becomes a virtue. This is because there is presumably no other way to ensure that there is sufficient financial capital in the system to finance new capital formation and create jobs . . . even (or especially) if the jobs do not result in any marketable good or service, a pillar of Keynesian economics with its obsession with “full employment.”
What if there is another way to finance new capital? What if there is a way to make every child, woman, and man into a capital owner without the necessity of having to accumulate savings before purchasing the capital?
We’ll look into that tomorrow.#30#