In the previous posting on this subject we took a look at a fundamental error in Keynesian economics, in all of the schools of economics based on the Currency Principle, in fact. That is the claim that production must exist before production can exist — the logical fallacy of reversing cause and effect, specifically, that you must refrain from consuming something before you can produce it.
Obviously, you can neither consume nor refrain from consuming something that does not yet exist; it’s a moot point, like saying “If we had ham, we could have ham and eggs, if we had eggs.” Yet Keynesian, Monetarist/Chicago, and Austrian economics all assume as a given that you cannot produce anything until and unless you have first consumed less than you have produced!
The idea that production must precede production is based on the fundamental assumption of the Currency Principle that money and credit are a commodity. Since the assumption is that you need money to carry out financial transactions, (such as financing production), it necessarily follows that you must first have money — savings — before you can do anything.
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| Irving Fisher |
This leads to the Currency Principle itself, which can be stated, “The quantity of money in the economy determines economic activity.” This is expressed mathematically in the Quantity Theory of Money equation formulated by Irving Fisher, M x V = P x Q, where M is the quantity of money, V is the velocity of money (the average number of times each unit of currency is spent during a year), P is the price level, and Q is the number of transactions.
The problem, of course, is that the Currency Principle interpretation of the Quantity Theory of Money equation is nonsense, mathematically speaking. Any high school algebra student can (or should be able to) tell you that you cannot solve for V, P and Q by knowing M. You need three more equations for the Currency Principle to work.
A moment’s thought should bring the realization that the “Banking Principle” better describes reality. Simply stated, the Banking Principle is that economic activity determines the quantity of money. The Quantity Theory of Money equation suddenly makes sense, and becomes soluble very easily if you know V, P, and Q.
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| "I reject Say's Law." |
The difference between the Currency Principle and the Banking Principle derives from the two views of money. In the Currency Principle schools of economics, money is viewed as a commodity. In Banking Principle economics, money is viewed as a tool. Thus, under the Currency Principle money creates transactions, while under the Banking Principle, transactions create money.
And that gives us Say’s Law of Markets, which some Currency Principle economists accept and some reject, but all get it wrong. Keynes and Marx, for example, rejected Say’s Law, while many Austrian economists accept it, but don’t understand it.
So, what is Say’s Law?
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| Jean-Baptiste Say |
Not by coincidence, Jean-Baptiste Say started with Smith’s principle that the only reason to produce is to consume, not to accumulate savings to finance future production or provide people with income by performing useless tasks. In his debate with the Reverend Thomas Malthus (author of the Essay on Population, 1797), Say baffled Malthus by pointing out that to consume, one must first produce.
According to Say, if you want to consume something, you must either produce or create it yourself, or produce or create something to trade to someone else if that someone else has what you want to consume. This is part of the nature of what it means to be a human person.
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| Rev. Thomas Malthus |
In addition, production is not by the human factor — labor — alone. Production is the result of both human and non-human factors, which Say categorized as labor, land, and capital, although what Say meant by “capital” is better understood as “technology.” If someone’s labor, land or technology is not enough to produce a sufficiency, then he must find the right combination of other factors to carry out the task.
This is “Say’s Law of Markets,” and is the way a natural law-based economy works. Production is for consumption, and if you want to consume, you must first produce. As Say’s Law is usually summarized, “Production equals income, therefore, supply (production) generates its own demand (income), and demand, its own supply.”
This necessarily implies that if you want something of value that someone else has — we are ignoring charity, redistribution, and theft for the sake of the argument — you must give something of value that you have. The “medium” by means of which one person exchanges and measures what he produces of value for what another person produces of value is called “money.”
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| Louis Kelso |
Thus, money — as Louis Kelso explained — is a social tool. It is a means whereby people can measure what they produce and exchange for the productions of others. It is not a thing valuable in and of itself, but of measuring value. The key to understanding money is to realize that money does not create value as the Currency Principle assumes. Instead, value creates money.
Fortunately for the future of the human race and freedom from the past savings assumption, promises — contracts — as well as existing production have value. If someone has something you want, but you have nothing he wants, you can promise him that if he gives you what you want now, you will give him what he wants in the future. If you trust one another to keep your promises, you have a deal. Money has been created by the extension of credit.
There are thus two types of legitimate money. These are, one, past savings money representing existing production. Two, there is future savings money, representing production not yet in the possession of the one promising to deliver it in the future, but which the people accepting the promise believe he will have at the agreed-upon time.
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| "I forbid contradictions." |
There is also “no savings” money, such as most consumer credit these days as well as virtually all government debt. Where past savings money is best used for consumption, and future savings money is best used for investment, no savings money (as should be obvious) is best not used at all. It may be necessary as a last-ditch expedient when all other recourse is exhausted, but not as the normal way of financing either private consumption or government operations.
Looking at the proper use of money reveals what appears to be a fundamental weakness in the Great Reset and similar proposals. Without exception — or at least any that we have found — the idea is not to make people productive and help them to be virtuous, but to provide as many people as possible with the power to consume what other people have produced.
This contradicts the human need to be useful and contradicts the common sense of Say’s Law. There is also the ancient prohibition against usury to consider — which is not what many people believe, and which must be understood if we are to understand the true meaning and purpose of money . . . which we will cover in the next posting on this subject.
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