As we saw in the
previous postings on this subject, the main theoretical difference between
the Currency Principle and the Banking Principle is that under the Currency
Principle the amount of money in the economy determines the level of economic
activity, while under the Banking Principle the level of economic activity
determines the amount of money.
Thus, the
Currency Principle and the Banking Principle are direct opposites
theoretically, and the picture does not improve when we get into practical
applications. The unavoidable corollary to
the Currency Principle is that it is impossible to produce anything unless
saving has first taken place . . . but that there cannot be any saving unless
production has first taken place.
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| Yup. I mean, Nope. I mean . . . |
That, of course,
is an unresolvable paradox, as we saw in the previous posting on this
subject. It does not mean, however, that
production cannot be financed out of existing savings. That is clearly not the case, for it is quite
common to do so, although using existing savings to finance new capital
formation is not the best way of doing so.
The main problem
with the Currency Principle is not that it is impossible, for new capital is
financed every day out of existing savings.
The problem is the belief that using past savings is the only way
that new capital formation can be financed.
The Banking Principle admits both past and future savings can be used to
finance new capital formation, but implies that past savings are best spent on
consumption (so that production = consumption), and that future savings are
best used to finance new capital formation.
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| Adam Smith |
Another thing
that baffles adherents of the Currency Principle is to realize that financing
new capital formation does not have to throw the system out of whack. The ideal situation, of course, is that
production = consumption. This, in fact,
is Adam Smith’s first principle of economics: “Consumption is the sole end and
purpose of all production.”
“But” (you ask) “if
you are investing in new capital, that isn’t consumption, it’s investment! That means that production and consumption
are not going to be equal!”
That is a very
good point, but it’s also another example of a “fallacy of equivocation” that
we saw in the previous posting. It
confuses the political and economic meaning of “consume” with the financial and
accounting meaning of the same word.
In economics and
politics, there are two kinds of goods: capital goods and consumer goods. Capital goods are goods used to produce other
goods, while consumer goods are those that are used to satisfy human wants and
needs. If you really want to get
technical, capital goods satisfy human wants and needs indirectly by producing
consumer goods that satisfy human wants and needs directly.
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| Medieval philosophical discussion. |
Thus (in a
sense), capital goods and consumer goods both satisfy human wants and
needs. The former just do it indirectly,
while the latter do it directly. The
Currency Principle therefore distinguishes between direct and indirect
consumption, and implies that direct consumption and indirect consumption are
qualitatively different, that is, that consumption means one thing when it is
indirect, and another thing when it is direct.
This is the
Medieval “potentiality versus actuality” argument all over again. We won’t go through the thousands of pages of
argument for this, however. We’ll just
note that, in certain circumstances, there is no qualitative difference between
potential and actual, only a difference in degree.
For example, a
child is as human, and is human in the same way as an adult, even though all
the potentialities of being a human being have not developed in the child, and
might never be developed, for whatever reason.
The child is still an actual human being, a potential adult, but not a
potential human being.
And this relates
to consumption . . . how?
Where the
Currency Principle assumes that consumption is different if it is direct or
indirect, the Banking Principle simplifies matters and assumes that consumption
is consumption — period. Under the
Banking Principle, capital goods and consumer goods are both produced in the
same sense, and both are consumed in the same sense.
Yes, you call it
by different terms, depending on the type of capital good you are
consuming. You might be “depleting your
inventory of raw materials,” “depreciating your machinery,” “amortizing the
cost of an asset over its useful life,” but these are all ways of saying you
are consuming a capital good.
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| "Don't judge me." |
If that worries
you, consider the fact that there are countless ways to refer to consuming
goods directly to meet your wants and needs, e.g., just to describe “eating”
we have a small selection of the different ways we have of saying it: consume, devour, ingest,
partake of, gobble, gobble down, gobble up, gulp, gulp down, bolt, bolt down,
wolf, wolf down, cram down, finish, finish off, swallow, chew, munch, chomp,
champ, guzzle, nosh, put away, pack away, tuck into, tuck away, scoff, scoff
down, demolish, dispose of, make short work of, polish off, shovel down, get
stuck into, stuff one's face with, stuff down, pig out on, sink, get outside
of, get one's laughing gear round, gollop, shift, scarf, scarf down, scarf up,
snarf, snarf down, snarf up, inhale, ingurgitate . . . and that’s a short
list.
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| Sorry, Milord Keynes. Investment IS consumption! |
The bottom line
here is that, assuming that production is only for consumption, then the
Banking Principle makes more sense than the Currency Principle. That’s because the Currency Principle implies
that some consumption isn’t the same as other consumption, while the Banking
Principle implies that all consumption is the same, as long as it is consumed
in some way. Direct or indirect is
irrelevant.
“But” (you ask) “what
about the difference between consumption and investment?”
Another good
question — and a very difficult one to answer, because there is almost always
an extremely subtle fallacy of equivocation involved.
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| "Are you sure you haven't confused us with somebody else?" |
You see,
investment is one of the reasons you consume something. It doesn’t change the fact of
consumption at all. It only changes the reason
for consumption.
Thus, if you are
consuming a thing in order to satisfy your wants and needs directly, you are
consuming in the economic sense, but not in the financial sense. If you are consuming a thing in order to
satisfy your wants and needs indirectly, you are consuming in the financial
sense, but not in the economic sense.
See what we mean
about this being a difficult question to answer? Using the same word in its different senses
just begs for economists to come along and confuse people even more. Perhaps an example will help make things
clear.
Smith, our new
farmer from the previous posting on this subject, has just harvested a crop of
corn. Most of it he sells for the
$10,000 cash it brings him. Some of it
he grinds into meal to bake his daily (corn) bread. The rest of it he sets aside for use as seed
next year.
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| "No, I'm Negotiable Hayes, and he's Kid Currency." |
Of the $10,000,
Smith pays Jones $7,500 ($5,000 principal payment and $2,500 rental), and the
government $1,000 (taxes). He has
consumed $8,500 and saved $1,500. Of the
cornmeal, Smith has saved it all, to be consumed over time as he makes his
dinner. The seed corn is saved until
Spring planting, when he consumes it by putting it into the ground to grow a
new crop.
Of the $7,500
Smith paid to Jones, $5,000 is investment (indirect consumption to produce
other goods), and $2,500 is direct consumption (rental for the use of the
land). The $1,000 tax is direct
consumption to meet the need to pay taxes (and stay out of jail). The $1,500 savings will be spent over time to meet direct consumption needs requiring a cash outlay. The cornmeal is (eventually) direct
consumption, while the seed corn is investment — indirect consumption.
Note that in
every case, whether the consumption is direct or indirect, it’s still all consumption. All the goods produced (in this case the
single good of corn) were consumed.
Production equaled consumption.
The consumption was called by different terms, but it was still
consumption, one way or another.
Believe it or
not, understanding what constitutes consumption is an important point in
understanding money. It is essential to
our understanding of something called “Say’s Law of Markets,” which we will
look at in the next posting on this subject.
#30#
