In the previous posting on this subject, we looked at some of the discrepancies and contradictions in Keynesian economics. Today we take a look at what may be the single biggest problem with the economics of the architect of the New Deal.
So far in these postings we have seen that limiting our understanding of money and finance to past savings can lead to serious problems and contradictory, even ludicrous conclusions. Nor is this by coincidence. The simple fact is that the past savings assumption, what Louis Kelso and Mortimer Adler referred to as “the slavery of savings” in the subtitle of The New Capitalists (1961), their second book, does not describe reality, and is therefore not true.
This can be proved mathematically by the application of basic high school algebra. First, however, we need some background.
As we noted in previous postings, there are two theories about money, the past savings assumption and the future savings assumption. Immediately a difference arises, because while the future savings assumption acknowledges the validity of past savings and its proper use in consumption, the past savings assumption does not even admit the existence of future savings.
That, however, is not the main point here, which is that the two assumptions have diametrically opposed principles underlying them. In the past savings assumption, the principle is that the amount of money determines economic activity. In the future savings assumption, the principle is that economic activity determines the amount of money.
Ordinarily, this difference would have been of interest only to academics and philosophers; it strikes most people as arguing whether the chicken or the egg came first. Unfortunately, politicians got involved and matters went downhill from there. What happened was the French Revolution and a new concept of the Nation-State and of total war, followed by the Napoleonic Wars . . . and the need to finance them.
Previously, as a general rule, wars in Europe had been fought with relatively small professional armies financed with taxes. With the French Revolution and the self-imposed mission of the revolutionaries to bring the New Order to the rest of the world, the idea of mobilizing an entire nation for war took hold.
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| The Panic of 1825 |
Costs of war along with the role of the State increased geometrically. Politicians were faced with the choice of raising taxes, or financing a war effort with unbacked debt and fiat money. They chose debt and fiat money, laying the groundwork for the future development of the military industrial complex.
Money changed from being an abstract symbol to measure value and facilitate transactions, to a commodity with its own inherent value. Government monetary and fiscal policy were developed based on the assumption that money must exist prior to production and economic transactions instead of being created by production and transactions.
Disconnecting money from production in this way caused the Panic of 1825 and the start of the modern business cycle of “boom and bust.” It also ensured that when the charter of the Bank of England, at the time the most important central bank in the world, came up for renewal in the early 1840s, the past savings assumption — which was now known as “the Currency Principle” — would be the monetary theory embodied in the law. The future savings assumption (now known as “the Banking Principle”) — the theory behind commercial/mercantile and central banking — was edged out as the monetary theory and practice of the British Empire became based on the past savings assumption.
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| Save it all you like, it ain't gonna rise agin'. |
Both sides in the American Civil War financed the war using debt (the Union by choice, the Confederacy by necessity), introducing the Currency Principle into the American economy. This was despite the fact that the power of Congress to issue fiat money was expressly removed from the draft of the U.S. Constitution during the debates of 1787.
The National Banking System established in 1863 cemented the past savings assumption into the U.S. financial system. Ironically, while the National Banks functioned only as past savings lenders for small farmers and businessmen, big businesses were able to use them as commercial banks and create all the money they needed out of future savings. Once the “free land” available through the Homestead Act ran out, the concentration of wealth in the hands of a relatively small group accelerated.
After three financial panics and two “Great Depressions,” populist demand for fiscal, monetary and financial reform resulted in the income tax and the establishment of the Federal Reserve System. The Federal Reserve was intended to replace the three inelastic, government debt-backed reserve currencies with a single elastic, private sector asset-backed reserve currency. Instead, it was almost immediately diverted to funding America’s entry into World War I and later the Keynesian New Deal by creating massive quantities of fiat money backed with government debt through a loophole intended to retire money backed with government debt.
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| Keynes, economic lizard, er wizard. |
It could be argued that funding the war effort using debt instead of taxes was a matter of expedience. No such justification exists for the New Deal, however. As Keynes made clear in his Treatise on Money (1930) and General Theory, the goal was the complete transformation of the economic system. The idea was to shift from a free market economy still characterized at least in the United States by the remnants of small ownership, into an economy controlled by the government through manipulation of the tax and monetary systems. As Keynes explained,
The State will have to exercise a guiding influence on the propensity to consume partly through its scheme of taxation, partly by fixing the rate of interest, and partly, perhaps, in other ways. Furthermore, it seems unlikely that the influence of banking policy on the rate of interest will be sufficient by itself to determine an optimum rate of investment. I conceive, therefore, that a somewhat comprehensive socialisation of investment will prove the only means of securing an approximation to full employment; though this need not exclude all manner of compromises and of devices by which public authority will co-operate with private initiative. But beyond this no obvious case is made out for a system of State Socialism which would embrace most of the economic life of the community. It is not the ownership of the instruments of production which it is important for the State to assume. If the State is able to determine the aggregate amount of resources devoted to augmenting the instruments and the basic rate of reward to those who own them, it will have accomplished all that is necessary. (Keynes, General Theory, op. cit., V.24.iii.)
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| Henry George |
In other words, as the agrarian socialist Henry George had observed in Progress and Poverty (1879), legal title — private property — is irrelevant as long as the State can exercise control by receiving the income or determining who may receive that income or in what degree. The State becomes, in effect, “the universal landlord without calling herself so.” (Henry George, Progress and Poverty. New York: Robert Schalkenbach Foundation, 1992, 406.)
All of this was ultimately justified — and continues to be so to support such proposals as the Great Reset and similar measures — by the assumption that only past savings can be used to finance new capital formation. This results in the belief that the quantity of money in an economy determines the level of economic growth, and also restricts capital ownership as a rule to the already-wealthy.
And this causes a problem that we will look at in the next posting on this subject.
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