Yesterday we
posted a brief discussion of why the “classic” Keynesian money multiplier — on
which virtually every government on Earth bases its monetary and fiscal policy
— simply doesn’t work. The Keynesian
money multiplier, in fact, is based on an accounting fallacy and a complete
misunderstanding of money, credit, finance, and (especially) banking.
 |
| Harold Glenn Moulton |
You don’t want to
take our word for it, though. You can
work it out for yourself on paper just by drawing a flowchart, or “following
the money” by tracing the transaction with “T accounts.” That is, in fact, what Dr. Harold G. Moulton
did back in 1935, soon after the money multiplier theory came out. Moulton disproved it almost immediately, so
(of course) it has become political and economic orthodoxy that must not be
questioned.
This is shown in
Chapter VI of The
Formation of Capital, “Commercial Banks and the Supply of Funds.” Today’s selection is from page 75 to page 77
of both the 1935 and 2010 editions.
In
order to set the stage for the analysis in this and following chapters, it is
necessary briefly to summarize our findings up to this point. We raised at the
beginning a basic problem of economic organization, asking whether the apparent
necessity of reducing the flow of funds through consumption channels in order
to provide funds for capital formation did not result in an economic dilemma.
At the end of Chapter III we arrived at the conclusion that if capital
formation is to take place on an extensive scale, there must be a simultaneous expansion in the flow of
funds through consumption and investment channels. In Chapter IV a second
conclusion was reached, namely, that expansion and contraction in the output of
capital goods and consumption goods, in fact, occur not alternately but
concurrently. In Chapter V we found that fluctuations in business activity in
the United States have usually manifested themselves first in changes in the output of consumption goods rather than of
capital goods.
The
analysis of consumption in relation to capital formation which we have made in
the last two chapters has run in terms of the actual production of goods and
services. We must now return to a consideration of the flow of funds by means
of which economic enterprise is carried out. It is evident that if the creation
of new capital, as we have indicated, occurred chiefly when consumption was
also expanding, there must somehow have been a simultaneous increase in the
flow of funds through consumption and investment channels. How has this been
made possible?
In
Chapter II we presented a general picture of the financial institutions which
are involved in the transfer of funds saved by individuals to business
enterprisers interested in expanding productive plant and equipment. Among
these institutions the commercial bank was mentioned as playing some part in
the accumulation of savings deposits which were rendered available for long‑term
investment. Besides acting as an intermediary institution in the transfer of
funds from savers to capitalistic enterprisers, the commercial banks, taken as
a system, create or manufacture great quantities of funds which are rendered
available, like any other money, for the manifold requirements of business
enterprise. As we shall hope to show, these institutions have played a role of
fundamental significance in connection with the formation of productive
capital. It is the commercial banking system, in fact, which has enabled a
pecuniarily organized society to escape, in considerable measure, from the dilemma
which has been outlined in Chapter III.
We
are here interested not in the role which commercial banks play in transferring funds but in their capacity
to create credit instruments which are ordinarily the equivalent of money. In
this respect they are a generating force, a sort of economic pulmotor [a device for
forcing air into a person’s lungs to prevent asphyxiation — ed.].
In
analyzing the significance of commercial banks in connection with capital
formation it will be expedient to break the discussion into three parts. The
present chapter will be devoted to an explanation of the process by which the
commercial banking system manufactures credit in general; Chapter VII will show
the purposes for which bank credit is extended; and Chapter VIII will indicate
the way in which the commercial banking system has facilitated the production
of new capital goods.
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