The Currency Principle

It has come to our attention that we may occasionally use words or concepts on this blog that many people have difficulty understanding, especially when we talk about money.  For example, a question came up recently about the terms “Currency Principle” (or School) and “Banking Principle” (or School).

Harold G. Moulton

We’re never quite certain how to start a discussion on a topic most people don’t know too much about.  Since this is a discussion about the difference between the Currency Principle and the school that adheres to the Currency Principle, and the Banking Principle and the school that adheres to the Banking Principle (see how complicated it is already?), it might be best to define our terms before we start the discussion.

Of course, for any reader really in to this sort of thing, the definitions alone will be sufficient to realize what the situation is.  For those people, they don’t need to go any further, and should immediately purchase a copy of The Formation of Capital by Dr. Harold G. Moulton, and download free copies of The Capitalist Manifesto and The New Capitalists, as they have the background to grasp instantly the points being made about money and credit.

What is the “Currency School”?

Not to get simplistic, but the “Currency School” is the rather loosely defined group of individuals and economic theories that adhere to some version of the “Currency Principle.”  Sometimes referred to as “the British Currency School,” it became identifiable as something distinct in the 1840s in England during the debates about rechartering the Bank of England, founded in the late seventeenth century as the world’s first true central bank.

Sir Robert Peel

Ironically, the three individuals credited with being the founders of the Currency School — Sir Robert Peel (the Prime Minister), Colonel Robert Torrens, and Samuel Jones-Loyd (Lord Overstone) — didn’t understand money, credit, banking, or finance!  They did, however, have an immense amount of political and financial power.  Since most other members of parliament didn’t understand money, credit, banking, and finance either, Peel, Torrens, and Overstone were able to get the central bank of the entire British Empire rechartered on their terms . . . even though they were completely wrong.

What is the “Currency Principle”?

The Currency Principle, the chief doctrine of the Currency School, is that the amount of money in the system determines economic activity.

That’s it.  It’s very simple, but it has almost unbelievable implications.  Under the Currency Principle,

Colonel Robert Torrens

·      There must first be money in the system before there can even be a system.

·      No exchanges (economic transactions) can take place unless money already exists.

·      There can be no production without first accumulating money in the form of savings to finance the production.

·      Only people who are rich enough to save can produce with anything except human labor, thus, only the rich should own capital.  (As John Maynard Keynes declared in the book that established his reputation, “The immense accumulations of fixed capital which, to the great benefit of mankind, were built up during the half century before the war [World War I], could never have come about in a Society where wealth was divided equitably.” (John Maynard Keynes, The Economic Consequences of the Peace (1919), 2.iii.)

·      Whoever is in charge of creating money must decide how much money to create before economic activity can take place.

Samuel Jones-Loyd, Lord Overstone

There are other implications, of course, but these are enough to suggest the fundamental flaw of the Currency Principle, and thus of every economic system or political policy based on it.  It is a flaw so obvious, a contradiction so huge, that Currency School economists and politicians can only deal with it by ignoring it and pretending it doesn’t exist.

And that is?

If (as Keynes insisted) “savings” always means the excess of past production over past consumption, and production is impossible without first reducing consumption below production, then it necessarily follows that consumption must be reduced before any production can take place.  That means that nothing can be produced until something has been saved out of production . . . that hasn’t even taken place!

Yes, you read that right.  Followed to its logical conclusion, the Currency Principle assumption that production can take place only after savings have been accumulated, means that production can only be financed out of production that has not yet taken place!  Consumption must come before production!

You see the inherent contradiction?  If, as the Currency Principle necessarily implies, production can only take place once production has been saved from consumption . . . where did the original production come from out of which savings were generated????????

John Maynard Keynes

You can now understand the panic that something like binary economics causes anyone who believes in the Currency Principle.  If they admit that — consistent with their assumptions — consumption can take place before production, they are clearly in error.  You cannot consume what does not exist.

If, on the other hand, they admit that there has been production by any means whatsoever that was not preceded by saving, then their entire system goes up in smoke.  Everything in the Currency School is based on the assumption that saving must precede production.

You see the paradox?  It’s like your saying “Everything I say is a lie.”  If everything you say is a lie, then you are lying when you say you are lying, which means you are telling the truth about being a liar, which can’t be true because you are lying . . . .

Now you know why you didn’t understand economics in school.  If you can’t produce without first saving, and you must first produce before you can save, then you can’t produce without saving, and you can’t save without producing, but you can’t save without producing . . . .

Obviously, the Currency Principle makes no sense at all, even though it is the fundamental assumption behind Keynesian, Monetarist/Chicago, and Austrian economics, every form of socialism ever invented, and just accepted as a given by capitalism.

In the next posting on this subject we will look at the Banking Principle, and you will be astounded at how simple it is to understand.

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