As we saw in the previous posting on this subject, John Maynard Keynes established his reputation with the publication in 1919 of The Economic Consequences of the Peace. In the book he made the remarkable — and demonstrably false — statement that the world could not possibly have advanced to the stage of economic development it enjoyed before the outbreak of World War I had not ownership of capital been concentrated in the hands of a few people.
Despite the fact that what Keynes said couldn’t possibly be true, it was exactly what the rich and powerful wanted to hear. This is because it justified (or, more accurately, rationalized) their wealth and position.
Had that been all, however, the damage Keynes wrought would have been limited. Unfortunately, with the growing concentration of wealth and power in fewer and fewer hands, and with more and more people unable to meet their wants and even needs adequately without government assistance, the demand increased for State involvement in the economy.
The tax base degenerated as people’s real incomes declined. At the same time, the belief continued to spread that the only way to finance new capital formation is to produce far more than could be consumed and somehow turn the unconsumed production into money savings. This would create jobs for non-owning workers.
As technology advanced, however, and the productive capacity of machinery far outstripped that of human labor, private employers could no longer pay workers living wages and finance new capital at the same time — or so they thought. Consequently, as the 1920s and 1930s wore on, more and more countries abandoned precious metal standards for their currencies and permitted the State to manipulate the value of the currency for political ends, whether to redistribute sufficient demand through inflation or to try and give a country a trade advantage over others.
This created a curious paradox. Adam Smith’s first principle of economics as stated in The Wealth of Nations (1776) is that “Consumption is the sole end and purpose of all production.” Production in Smith’s system is the result of land, labor, or capital (in binary economics, we group land and capital together as the non-human factors of production).
Keynes’s economic system is founded on the contradictory principle that all production is due to labor. Land and capital at best only enhance human labor and are not independently productive. Evidently Keynes believed that self-service elevators simply enhance a person’s ability to raise him- or herself up in the air with a single finger.
To Smith, money can be created as needed by backing banknotes — new money — with the value of existing or future wealth. The only thing holding back economic development and production is the lack of financially feasible productive projects and the demand for collateral to ensure the creditworthiness of borrowers so that the new money can be repaid and cancelled.
To Keynes, money is a special creation by the government that is backed by the State’s ultimate ownership of all existing wealth, which it can demand by imposing taxes or manipulate by unilaterally altering contracts and changing the value of the currency. As Keynes declared — again without presenting a shred of evidence or offering any proof:
|John Maynard Keynes|
It is a peculiar characteristic of money contracts that it is the State or Community not only which enforces delivery, but also which decides what it is that must be delivered as a lawful or customary discharge of a contract which has been concluded in terms of the money-of-account. The State, therefore, comes in first of all as the authority of law which enforces the payment of the thing which corresponds to the name or description in the contract. But it comes in doubly when, in addition, it claims the right to determine and declare what thing corresponds to the name, and to vary its declaration from time to time — when, that is to say, it claims the right to re-edit the dictionary. This right is claimed by all modern States and has been so claimed for some four thousand years at least. It is when this stage in the evolution of money has been reached that Knapp’s Chartalism — the doctrine that money is peculiarly a creation of the State — is fully realized. (John Maynard Keynes, A Treatise on Money, Volume I: The Pure Theory of Money. New York: Harcourt, Brace and Company, 1930, 4.)
This, as one of P.G. Wodehouse’s characters might say, is pure banana oil. It is a complete fantasy, displaying an egregious lack of understanding of the fundamental principles of money — and this in the opening passages of a book that Keynes intended as his magnum opus. Friedrich von Hayek shredded Keynes’s treatise on the grounds that it was “too collectivist,” but ironically — the Austrian school’s concept of money being no sounder than that of Keynes, albeit a great deal more consistent — von Hayek completely missed the significance of this passage, the most collectivist in the entire book!
|Friedrich von Hayek|
Both Keynes and von Hayek made the same mistake, although Keynes did it in a more damaging way. Both assumed as a matter of course that the quantity of money determines the level of economic activity (Currency Principle), where Smith, Jean-Baptiste Say, and others could show how the level of economic activity determines the amount of money (Banking Principle) . . . IF (and only if) businesses, banks, nor the State create money backed by what Henry Thornton, the “Father of Central Banking,” called “fictitious bills,” that is, financial instruments backed by fraudulent or non-existent assets, such as government debt backed by future tax collections. (Again ironically, von Hayek wrote an introduction to the 1939 edition of Thornton’s 1802 classic, An Enquiry Into the Paper Credit of Great Britain which he interpreted according to his own Currency Principle theories without regard to Thornton’s actual Banking Principle theories!)
This was a disaster. Obviously, if new capital formation can only be financed out of past savings, and technology is increasing in cost at a tremendous rate, there must be a class of persons, relatively small in number, whose capital produces so much that the few owners cannot possibly consume it all, and can (or must) use it to finance new capital. This presumably creates jobs so that non-owners can produce and therefore consume because only labor is productive . . . except when capital is, producing goods that should not be consumed because the excess production is needed to finance new capital to create jobs for people displaced by advancing technology. . . .
Don’t worry if that sounds as if it doesn’t make sense. You’re right. It doesn’t make sense. It does, however, pander to both capitalists and socialists by telling them what they want to hear. The capitalists hear that they should be the owners because it is more efficient that way. The socialists hear that the State (meaning bureaucrats) should be the owners, because that is more compassionate. Keynes managed to tell both what they wanted to hear by proposing what can be called with equal accuracy capitalized socialism or socialized capitalism with his system in which capitalists own, but the State controls by manipulating the currency and the money supply.