In the previous posting on this subject, we looked at the “Currency Principle,” the fundamental assumption (obviously) of the Currency School that is the basis of virtually all modern economic thought. We discovered that the Currency Principle can be stated very simply as the belief that the amount of money in the system determines the level of economic activity.
In other words, under the Currency Principle, if there is no money, there is no economic activity. If there is a lot of money, there is a lot of economic activity. All this derives from the assumption that “money” consists of a claim on existing savings.
|"Let's see. Greed is good. I'm greedy. I'm good!"|
We also discovered that the Currency Principle that is the basis for Keynesian, Monetarist/Chicago, and Austrian economics as well as all forms of socialism and capitalism, embodies an inherent contradiction that invalidates the entire principle. That is, production cannot take place without first saving, but saving cannot take place without first producing.
Fortunately, binary economics avoids the inherent contradiction of the Currency Principle by accepting the Banking Principle. The Banking Principle can be stated as easily and simply as the Currency Principle. The Banking Principle is that the level of economic activity determines the amount of money in the system.
This is exactly the opposite of the Currency Principle: that the amount of money determines the level of economic activity. In finance terms, under the Currency Principle production is a “derivative” of money, while under the Banking Principle money is a derivative of production.
To put it another way, the Currency Principle is really a version of the old paradox, Which comes first, the chicken or the egg? The Banking Principle assumes as a given that we already have either eggs or chickens, and the real question is what to do with our eggs or chickens. Do we consume them, or do we trade them to others for what we want to consume?
“Ah,” you might say, “How did you get the eggs or chickens in the first place? Don’t they have to exist in the form of savings before you can even obtain them?”
Excellent question, and a good point — and it raises the issue of how we resolve the fundamental flaw in the Currency Principle and why the Banking Principle is more rational.
The fact is that the Currency Principle is based on what is called a “logical fallacy of equivocation.” This is a fancy way of saying that somebody who commits a “logical fallacy of equivocation” has taken a word, phrase, or concept that means one thing in one set of circumstances, and another thing in a different set of circumstances, and claims that they mean the same thing. It also goes the other way, that a word, phrase, or concept that means the same thing even in different circumstances is taken as meaning something different.
For example, take the word “fix.” When you fix an automobile, you repair it so that it runs properly. When you tell someone, “I’ll fix you!” you don’t mean you will repair him, but harm him in some way. When you fix a horse race, you are cheating. The exact same word in all three circumstances, but three very different meanings.
|We said "tort" not "torte" . . . forget we said anything. . .|
Thus, someone whom you ask to fix your car destroys it thinking that is what you wanted has committed a “logical fallacy of equivocation” and a tort, even a crime if the court decides he should have known the different meanings of the word “fix” and applied them reasonably, i.e., would a reasonable man whom you ask to fix your car have destroyed it, thinking that is what you meant? Probably not, therefore a crime has probably been committed.
The logical fallacy of equivocation of the Currency Principle is the massive confusion regarding the concepts of saving and production . . . especially who or what is doing it.
You see, Currency Principle adherents are both right and wrong when they say that saving must precede production. They are right that something must exist out of which something can be produced, but wrong that this is necessarily classed as “savings.”
Currency Principle adherents such as Keynes are correct — up to a point — in defining savings as the excess of production over consumption. The problem is that they (probably unconsciously) shift the meaning of savings from the individual to the aggregate and back again, and sometimes take both meanings at the same time, and then insist that all saving must precede production.
The simple fact is that production is individual, not aggregate. Actual people and capital instruments are what produce; aggregates — abstractions — do not produce.
And the same goes for saving. “Saving” is not something that occurs in aggregate. Aggregate saving only exists because actual people are saving or have saved.
|Sometimes false analogies are pretty obvious|
Thus, the Currency Principle is correct that nothing can be produced overall if nothing exists anywhere out of which it can be produced. It is incorrect when that is extended to individuals or groups engaged in production. The Currency Principle is based in part on a “false analogy,” that is, because nothing can be produced out of nothing at any time (true), no one can produce anything if he or she personally does not possess anything at the present time (false).
Obviously you cannot produce something out of nothing. That is not what it means under the Banking Principle to say that production is possible without the use of existing savings. It means — and it means only this — that an individual or group can produce something if the individual or group has no existing saving. It does not mean that an individual or group can produce something out of nothing.
We’ll repeat that because it is a key point. Nothing can be produced out of nothing. The Currency Principle and the Banking Principle both agree on that. The Currency Principle takes that obvious truth and claims that because nothing can be produced if nothing already exists, then it necessarily follows that if an individual or group has nothing at the moment, then that same individual or group can never have anything, even if others have all they want or need.
Under the Banking Principle, however, nothing is easier than arranging for those who have nothing to have something — without taking it from anyone else. All it takes is a good idea and the ability to put the idea to work. All the Banking Principle implies is not that something can be created out of nothing, but that an individual or group can start with nothing, and gain something without taking it away from somebody else.
For example, a man (we’ll call him Smith) comes to a town with only the clothes on his back and a solid character reference from a trusted authority. He wants to be a farmer, and there is a good 160-acre farm for sale. The current owner (whom we’ll call Jones) is tired of farming and wants to cash out and retire on the proceeds.
Smith goes to Jones and says, “I see you want to sell your farm for $100,000. How much profit do you make every year from the farm?”
Jones says he makes a minimum $10,000 clear a year plus all the food, fuel, and clothing he needs, and the taxes are low, only $1,000 per year.
Smith says, “I offer you no money down, but $5,000 a year for 20 years, plus an annual rental of $2,000, to be decreased by 5% every year, paid after the crop is harvested and sold. Here is a character reference from a trusted authority.”
Jones says, “It’s a deal.”
Smith was able to purchase Jones’s farm without the use of past savings using the Banking Principle. Smith used savings, of course. Instead of reducing his consumption in the past, however (past savings), he increased his production in the future (future savings). Smith purchased a capital asset without having any savings now, and paying for it with the profits of the capital itself.
That is what it means under the Banking Principle to say that new capital can be financed without using existing savings. In the next posting on this subject, we’ll look at how the Banking Principle developed.