It’s gotten so predictable that we forgot to predict it. We kept telling people that binary economics and the Just Third Way are based on something called “the Banking Principle.” As we’ve repeated ad nauseam, the Banking Principle is that the amount of money in the system depends on the velocity of money, the price level, and the number of transactions, not the other way around.
|Money is not just currency, but all things transferred in commerce.|
Another thing we keep repeating is that money derives from production; production doesn’t derive from money. Money being defined as “anything that can be accepted in settlement of a debt” (“all things transferred in commerce”), and therefore is the medium of exchange, you can’t exchange something that doesn’t exist. You can exchange the value of existing wealth that has been produced (past savings), and the value of future wealth that will be produced (future savings), as well as current income, but you cannot exchange the value of something that has not, and will not, be produced.
Under Say’s Law of Markets, existing production should go to past savings and current income to clear existing inventories. If you set something aside to finance new capital formation, you have decreased demand by that much (and made it less likely that you will need new capital formation. . . .). Logic therefore dictates that you finance consumption out of past savings (past decreases in consumption) and current income, new capital formation out of future savings (future increases in production), and the unpaid balance of credit owed on existing capital out of current income. Current income is a "hybrid" critter: it can be used to clear existing inventories and production of goods and services AND pay down debt on capital acquired on credit. Why? Because to the supplier of the capital being paid for, that was consumption. He doesn't care what you used the capital for, or even if you used it at all, as long as you pay for it. Strictly speaking, the investment in new capital was at the time the capital was purchased on credit. Exchanging the debt for cash coming out of current income is "consuming," not investing . . . sort of (that's why the expense of capital, "depreciation," takes place AFTER the capital is put to use and is "consumed" over time). Paying down the acquisition debt of capital is, confusingly, both production and consumption, keeping the equation in balance as well as recognizing financial and economic reality.
|Say just keeps turning up.|
So, what was it we failed to predict? That, having said something so many times, we thought we could get away with just assuming (yes, we know, “when you assume. . .”) that people were aware that we had said it . . . and said it, etc. . . . so we instantly got accused of ignoring everything in the alleged real world we didn’t put into our example of how Say’s Law works.
First and foremost, of course, was the Keynesian assumption that it is impossible to produce anything without first saving, with “saving” defined as not consuming everything that has been produced. Keynes claimed he knew of no one who defined saving any other way . . . and then spent twenty pages in his General Theory ridiculing all the stupid people who defined savings in other ways. . . .
Returning to our argument, do you see the most immediate and fundamental problem with the assumption that it is impossible to produce anything until and unless you save something out of past production? Of course you do: if, as Keynes claimed, the first principle of finance is that it is impossible to finance new production except out of past production . . . where did the first production come from?
|A first principle is always true.|
This really messes up Keynes’s assumption about the necessity for past savings in financing new capital formation. It cannot be a first principle because it clearly is not true in all cases. As Aristotle observed, a first principle is always true in all circumstances; it cannot be conditional. To say that the initial production, even at the dawn of time, came from past production, the claim itself is contradictory . . . which violates another requirement of a first principle that it not be contradictory!
If, however, you admit that — logically — the initial production of anything did not come out of existing production, you just invalidated the claim that new production can only come out of old production.
Then there’s the requirement that a first principle must rely on logic, not observation. Thus, Keynes’s declaration that he knew of no case where future savings had been used to finance new capital formation invalidated it as a first principle because it was (allegedly) empirical evidence, not a logical conclusion from reason.
In any event, the first principle of finance — if you ask someone who knows about finance — is to know the difference between a mortgage and a bill of exchange. (This has been said in a number of ways, but that’s the way financial historian Benjamin Anderson put it.)
And what is the difference between a mortgage and a bill of exchange? A mortgage is a “past savings” instrument, while a “bill of exchange” is a “future savings” instrument. A mortgage conveys an interest in something that the issuer possesses at the time he or she issues the mortgage. A bill of exchange conveys an interest in something that the issuer (the borrower) expects to possess and be able to deliver to the lender at the time the bill matures, but does not (necessarily) have in possession at the time the bill is issued.
|"But you need rich people . . . to give me money!"|
Both mortgages and bills of exchange can be used as money. Any contract, in fact, can be used as money, but mortgage and bill of exchange are the terms used to distinguish past savings money/contracts and future savings money/contracts, respectively.
Why is the difference important? Because if all new capital formation must be financed out of past savings, ownership of that new capital will be concentrated in the hands of those who can afford to save, and others will own nothing . . . which is precisely why Keynes said the world needed a few rich people with everybody else owning nothing.
Consequently, under the Keynesian assumption, the entire world and all economic growth is “enslaved” to savings, because there is no other way to produce. If, however, the Keynesian assumption is false — and we have just shown that it is, in fact, false — then there is no need for any individual, economy, or the world to be enslaved to savings. By financing with future savings, everyone can own. By financing with past savings, very few can own.