In the
previous posting on this subject, we looked at why Modern Monetary Theory (MMT)
is illogical. Specifically, it relies on
a mathematical impossibility, i.e., having
one equation with three dependent variables.
The bottom line is that in the Quantity Theory of Money equation, M x V
= P x Q, V, P, and Q determine M, not the other way around as MMT adherents
maintain. If you manipulate M, all you
do is screw up the system so that Say’s Law of Markets won’t function.
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| Debt and Taxes: Same old story, different name. |
Not unexpectedly,
adherents of MMT rejected the analysis, although those we heard from were
careful not to address the mathematical proof of what we said. Instead, they zeroed in on a related comment —
to be addressed in full in a future posting on this subject — to the effect
that the Keynesian money multiplier is utter nonsense. Because we gave no support for that statement
(having made our case in numerous previous postings), they felt themselves on
safe ground.
We will therefore
once again demonstrate the fallacy of the Keynesian money multiplier, but
(again) it will have to be in a future posting on this subject. This is because if someone does not
understand how the science of finance really works, he (or she) will not
understand the fallacy of the Keynesian money multiplier.
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| Jean-Baptiste Say |
To begin, there
are two ways to finance new capital formation, which is the only thing we’re
looking at. Yes, consumer spending is
important — Say’s Law of Markets can’t operate without both halves of the
production/consumption equation — but we’re looking at 1) how new capital can
be financed, 2) in ways that create new owners of capital.
We are not
concerned with non-productive finance, such as funding government or
consumption. That is a different area. One thing at a time. Raising side issues calls to mind the scene
in the musical play 1776 in which one
of the delegates asks why the draft Declaration of Independence that is being
shredded during discussions doesn’t include any mention of deep sea fishing
rights. The John Adams character (played
by William Daniels on Broadway and on screen) stares for a moment, then
explodes in yet another tirade.
So, what are the
two ways in which new capital formation can be financed?
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| Lord Keynes |
·
Past
Savings. This is the fundamental assumption
of Keynesian economics, viz., that
new capital formation can only be financed by producing more than is consumed
and accumulating the excess in the form of money savings. That is, the all-important savings can only
be generated by reducing consumption in the past.
·
Future
Savings. This is the fundamental
assumption of Say’s Law of Markets, viz.
that new capital formation can be financed by making a promise to pay for the
new capital out of the future profits of the capital itself. That is, the all-important savings can be
generated either by reducing
consumption in the past or by increasing
production in the future.
The past savings
method of finance is the easiest to understand, and thus makes the most
persuasive case for the Keynesian paradigm.
Nor is it incorrect. The problem
is not in the method itself, but in the assumption that it is the only way to
finance new capital formation.
Using past
savings as the sole source of financing leads to an automatic dysfunction of
Say’s Law of Markets, which can be summarized as “Production equals income,
therefore supply creates its own demand, and demand its own supply.”
The difficulty
with Say’s Law in the past savings paradigm is that production equals income,
true, but not all income is spent on consumption, and therefore not all
production is consumed. Enough income (production)
must be set aside to finance new capital formation.*
*The fact that
financing new capital formation is itself a form of consumption from the
supplier’s point of view is ignored in Keynesian economics and other Currency
Principle schools. There is also the
issue of how production in excess of current consumption is supposed to be
turned into money savings, which Keynes “solved” by having the government back
new money with its own debt, thereby shifting ownership from producers to
whoever receives government largesse. Backing new money with government debt instead of private sector assets does not bring an economy back into balance, it throws it even more out of balance as the debt, not being self-liquidating, accumulates and become unrepayable.
In the past
savings paradigm, then, a modern industrial economy requires concentrated
ownership of capital in order to generate sufficient savings. Otherwise owners will use their capital
ownership income for consumption, and new capital will not be formed (Keynes actually called for the "euthanasia of the rentier," i.e., the elimination of small owners who use their capital income for consumption). When a private sector élite owns or controls capital, it is called capitalism. When a government
élite does so (and that government
can be anything from the petty dictator of a commune to the faceless Soviet
bureaucracy), it is called socialism.
There is a host
of other problems with relying on past savings as the sole source of financing
for new capital formation, but we’re looking at the mechanics of finance here,
not the systemic problems, which are a topic for another day.
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| Kelso: Why not use insurance for collateral? |
But are there no
problems with the future savings paradigm?
Yes, quite a few. The first and
most important one is that even many people who are using future savings to
finance new capital often don’t realize they are doing so! If you misuse a tool, especially one relating
to the “meta-tool” of money, chances are you are going to do a lot of damage
that you don’t even realize you are doing.
More immediately,
however, the big problem with the future savings paradigm is the universal
collateralization requirement, i.e.,
the fact that you need money to borrow money.
This is also a
problem in the past savings paradigm, but only if you borrow money. If you have enough money or can persuade
someone to lend you his, you buy capital.
If you don’t have enough money or can’t persuade someone to lend you his,
you don’t.
It is a permanent
and mega problem in the future savings paradigm. In the future savings paradigm people create
money for new capital formation . . . but what if the new capital does not make
enough in profits to repay the new money so it can be cancelled? The one(s) who created the money must be
repaid, or they take the loss instead of you.
To participate in
future savings financing, then, you need to have enough existing wealth for the
money creators to seize in the event the new capital does not pay off. This creates the illusion that even when
people are using future savings, they are really using past savings, which
creates no end of confusion.
Can this problem
be solved? Very easily. Since money creators just want to be repaid,
they don’t really care how (as long as it’s legal and honest, that is), Louis
Kelso said borrowers who don’t have past savings/existing wealth should use
insurance policies that pay off and retire a loan in the event of default.
This, of course,
is only the basic theory of future savings financing. How it is done in practice will be the
subject of the next posting on this topic.
#30#