THE Global Justice Movement Website

THE Global Justice Movement Website
This is the "Global Justice Movement" (dot org) we refer to in the title of this blog.

Tuesday, April 6, 2021

Financing Future Growth

We closed the previous posting on this subject by noting that while expanded capital ownership can restore Say’s Law of Markets and poke Keynesian economics and its unresolved paradoxes in the eye with a sharp stick, there was a problem.  It is itself a seeming paradox — or at least ironic — that the people who most need to become capital owners are the least likely to be able to afford it.


Further, under Keynesian assumptions, there is another curve thrown in.  Harold Moulton called it “the Economic Dilemma” in his book, The Formation of Capital (1935).  As he explained it, “The dilemma may be summarily stated as follows: In order to accumulate money savings, we must decrease our expenditures for consumption; but in order to expand capital goods profitably, we must increase our expenditures for consumption.”

In other words, if we consume in order to justify new capital investment, there isn’t enough money to pay for the new capital investment.  If, however, we save in order to finance new capital investment, we’ll have the money, but there won’t be the consumer demand to justify the new capital.  If you can afford it, you don’t need it, and if you need it, you can’t afford it!

Thus, the entire economy under the assumption that only existing accumulations of savings can be used to finance new capital formation is caught in an impossible situation.  Keynes attempted to solve this economic dilemma by advocating production for which there was no demand, and creating demand for which there was no production.

Dr. Harold G. Moulton


As a result of Keynes’s separating production and consumption, the government assumes mountains of debt, the benefit of which goes into the pockets of already-rich producers who turn into mega-billionaires, and soon trillionaires.  At the same time, the price level goes up so that consumers pay more for less, often borrowing money to do so, which also ends up in the pockets of producers.

Government and consumers assume a gargantuan debt, while the ultra-rich accumulate the claims on that same debt at an ever-accelerating rate.  Not only can’t the average non-owner accumulate enough money to purchase capital, he or she can’t even meet consumption needs without going into debt or receiving a government subsidy . . . which means the government assumed the debt instead of the consumers . . . who are also the taxpayers who will end up having to pay the government debt as well as their own.

There is, however, a way out of the economic dilemma, as Moulton explained in his book, at least a way out of the slavery of past savings in aggregate.  That is, instead of financing new capital formation with existing savings generated by having cut consumption in the past, use future savings generated by increasing production in the future.


Financing with future savings is, in fact, what commercial (mercantile) and central banks were invented to do.  Instead of first accumulating savings and then lending them out for investment, a commercial bank accepts a contract for a capital project,  generically called a “bankers acceptance.”  This contract — specifically a “bill of exchange” — represents the value of an income-generating project.

The bank “buys” the bill by issuing a promissory note.  In the old days, a bank would issue banknotes backed by the promissory note, but nowadays creates a demand deposit — a checking account — instead of issuing banknotes.  The promissory note is in turn backed by the bill of exchange, which is itself backed by the borrower’s ability to repay the loan, which is backed by the future stream of income that the project is reasonably expected to generate.  The borrower repays the loan with the future profits — increases in production in the future — instead of using existing accumulations of funds (past reductions in consumption).

People and businesses create money every day without the government


Whether banknotes or demand deposits, however, the end result is the same: something the borrower can use to finance an income-generating project and repay the loan out of future profits.  Of course, The borrower could go to everyone he or she deals with and persuade them to accept a bill of exchange — which businesses do all the time in “B2B” transactions — business to business.  In that case, the bills of exchange are called “merchants” or “trade” acceptances, and until recently, the vast majority of bills were used just that way, and most money in an economy was created privately between two people and never went through a bank.

G.K. Chesterton


Having private individuals create their own money is not really feasible unless the two parties know and trust one another, though . . . which is why commercial banks were invented, so that people only have to trust the bank’s promises, not each individual citizen’s promises  That’s also why central banks were invented: so that the promises of all commercial banks could be aggregated to make them less risky, being spread out among an entire economy, not just the area served by a single bank.

Thus — as should be obvious — the proper use of past savings is for consumption, while the proper use of future savings is capital investment.

Of course, we still haven’t answered the main question here, which is how this helps ordinary people become capital owners.  That was the genius of Louis Kelso.  Kelso took the analysis used by Moulton and realized — contrary to Keynes’s assumption that wealth must be concentrated in order to ensure sufficient funds for capital investment — that it’s actually very bad for wealth to be concentrated, and (as Jean-Baptiste Say hinted) an economy actually works better and is more stable if capital ownership is broadly distributed.

Louis Kelso


A couple of fellows by the name of G.K. Chesterton and Hilaire Belloc had made the same observation a generation or so previously, as did Pope Leo XIII and Pope Pius XI, but here at last was a way to make expanded ownership something other than a pipe dream.  There was, however, one final problem, which Kelso also solved: what do people without ownership or savings use for collateral?

It is a general rule of banking that you don’t lend existing money or create new money unless the lender has collateral, that is, other wealth that the bank can seize if the borrower doesn’t repay the loan.  This rule gets fudged a little when consumer debt or government borrowing is the issue, but that sort of unproductive debt is not what we’re talking about here.  This is about “good debt,” not “bad debt.”

Kelso realized that collateral is really just the lender’s way of insuring the loan.  That being the case, why not use an actual insurance policy?  It is, after all, easier to pay a $500 premium on an insurance policy for a loan of $100,000 with a “risk premium” of 0.5%, than to accumulate $95,000 in other wealth to satisfy a 95% coverage ratio for traditional loan collateral.  Further, the lender would be happier, as seized collateral is rarely sold for its full value and the lender takes a loss on most defaulted loans.  By using capital credit insurance as Kelso advocated, a lender would get the full amount of the outstanding loan balance repaid.  The lender wouldn’t make a profit, but neither would there be a loss.

In this way, every person could become an owner of capital without redistribution, raising taxes, or increasing government debt.  Such a proposal is embodied in the Economic Democrcy Act, which should be seriously considered for implementation by any government that wants a way out of the current economic dilemma.