Today’s blog posting is a selection from the book, Economic Personalism, which you can get free from the CESJ website, or from Amazon or Barnes and Noble.
As we saw in the previous postings on this subject from last week and the week before, Hilaire Belloc had a somewhat primitive understanding of money and credit. Fortunately, Louis Kelso’s understanding of the importance of money and credit was radically different from that of Belloc. This can be traced to Kelso’s deeper understanding of an institution fundamental to the functioning of every form of economy that can possibly be conceived.
[There were some nifty images to put in, but Google won't let me for some reason, even though I followed instructions.]
Belloc’s error can be traced to the fact that, whether or not he realized it, he accepted without question a flawed theory of money. This theory, known as “the Currency Principle,” not only undermines private property at the most fundamental level, it contradicts the nature of money itself.
Briefly, the Currency Principle is the theory that the amount of money and credit determine the level of economic activity in an economy. It assumes that money is a commodity, rather than (among other things) a means of measuring the value of labor and capital inputs to production, commodities, and all else of economic value.
One consequence of treating money as a commodity is that it becomes subject to speculation. This drives the price of units of currency up or down, distorting the market price of actual goods and services. Today, all mainstream schools of economics and most of the minor ones take the Currency Principle for granted.
In contrast, binary economics is based on a theory of money and credit known as “the Banking Principle.” This is the theory that the level of economic activity determines the amount of money and credit in the economy.
In its purest sense, following the Banking Principle, money is the medium of exchange. This necessarily implies that money is also a measure of value. It is impossible for two or more people to engage in a just transaction without agreeing on the equality of what is exchanged, and to do that they must have a common unit of measure. Thus, as Kelso explained,
Money is not a part of the visible sector of the economy. People do not consume money. Money is not a physical factor of production, but rather a yardstick for measuring economic input, economic outtake and the relative values of the real goods and services of the economic world. Money provides a method of measuring obligations, rights, powers and privileges. It provides a means whereby certain individuals can accumulate claims against others, or against the economy as a whole, or against many economies. It is a system of symbols that many economists substitute for the visible sector and its productive enterprises, goods and services, thereby losing sight of the fact that a monetary system is a part only of the invisible sector of the economy, and that its adequacy can only be measured by its effect upon the visible sector. (Louis O. Kelso and Patricia Hetter, Two-Factor Theory: The Economics of Reality. New York: Random House, 1967, 54-55.)
There are serious problems associated with departing from the Banking Principle and construing money and credit as a commodity. For example, if there is a standard for the currency and the standard is a commodity in limited supply, prices of all other goods and services will rise and fall in response to changes in the price of the standard, for reasons having nothing to do with the supply of and demand for the actual goods and services being exchanged. If the government controls the money supply, implements a flexible standard, and backs the currency with its own debt, the situation is much worse.
Determination of a monetary standard and proper management of a currency is a highly technical matter that we do not need to go into any further for the purposes of this discussion. What is essential here is coming to a better understanding of what money is, by looking at what money does — or is supposed to do if the financial system adhered to the principles of the Just Third Way.
The obvious place to start is with the first principle of economics of Adam Smith. As Smith expressed it in The Wealth of Nations, “Consumption is the sole end and purpose of all production.” (Adam Smith, An Enquiry into the Nature and Causes of the Wealth of Nations, IV.8.49.) In other words, in a rational market system, nothing is produced that is not intended to be consumed by someone.
This brings us to “Say’s Law of Markets.” Jean-Baptiste Say did not develop the law that bears his name, but derived it from the work of Smith, as Say acknowledged. Say did, however, explain it better than anyone else.
Say began with Smith’s first principle of economics, as he noted in his responses to Thomas Malthus. As Say argued, absent charity, theft, or some other form of redistribution, there is only one way to consume, and that is to produce.
You must either produce for your own consumption, or to have something to trade with others for what they produce that you want to consume. When governments issue money backed with their own debt, they are consuming without producing, which violates private property. Thus, as Say concluded in his first “Letter” to the Reverend Thomas Malthus,
[I]n reality we do not buy articles of consumption with money, the circulating medium with which we pay for them. We must in the first instance have bought this money itself by the sale of our produce. . . . It is therefore really and absolutely with their produce that they make their purchases: therefore, it is impossible for them to purchase any articles whatever, to a greater amount than those they have produced, either by themselves or through the means of their capital or their land.
The best, indeed, the only legitimate way to create money, then, is to convert “produce” (i.e., production) into money. Again, the details of how this can be done are complex and highly technical, and they are not essential to understanding the basic theory.
What we are interested in is Kelso’s theoretical point. That is, money is correctly viewed as a means of engaging in, measuring, and facilitating economic transactions.
As such, in a justly structured system the amount of money and credit should be linked by private property directly to existing and future marketable goods and services. This, as John Paul II noted, would “ensur[e], by means of a stable currency and the harmony of social relations, the conditions for steady and healthy economic growth in which people through their own work can build a better future for themselves and their families.” (Centesimus Annus, § 19.)
It is therefore possible to finance new capital formation by increasing production in the future instead of relying on decreasing consumption in the past. By collateralizing loans with capital credit insurance instead of with existing wealth owned by the borrower, it is possible to create sound money as needed to enable people who do not presently own capital to become capital owners.
This capital could be existing assets, but the bulk of it would probably be newly issued shares representing newly formed productive assets. It is only necessary that the new capital produce enough to pay for itself out of its own future earnings, and thereafter provide consumption income for the new owner.
Commercial and central banks were invented to expedite this process. Most modern central banks (like the U.S. Federal Reserve System) could finance a program of expanded capital ownership without requiring any new legislation. Operated properly, and all else being equal, there would always be exactly enough money and credit in the system, no more, no less, with neither inflation nor deflation.
Kelso’s breakthrough in economics and finance is as profound a breakthrough as that of Pius XI in moral philosophy and social doctrine. By solving the problem of how expanded capital ownership can be financed without redistribution or restricting current consumption, and guided by these principles, Kelso turned Catholic social teaching from an idealistic dream into a practical reality.
As noted briefly above, however, equally significant is Kelso and Adler’s presentation of economic justice as a complete system with input, out-take, and feedback-corrective principles. By defining the principle of participative justice, they offered a logical counterpart to the classical concept of distributive justice.
Their third principle of limitation, meant to discourage greed and prevent monopolies, was easily expanded into a feedback-corrective principle of “social justice,” as defined by Pius XI. These three principles of participative justice, distributive justice, and social justice make the moral basis of economic personalism explicit and link the moral absolutes of Catholic social teaching directly to the realities of everyday economic life.
In combination, the principles of economic justice, binary economics, and the act of social justice have the potential to guide people in establishing and maintaining a true personalist social order that empowers and thereby respects the dignity and sovereignty of every child, woman, and man on Earth.
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