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, November 2, 2021

The Formation of Capital

       In the previous posting on this subject, we looked at how financing new capital formation works with past savings and with future savings.  To recap, the past savings technique of finance means you accumulate savings by decreasing consumption in the past, while the future savings technique involves increasing production in the future.


In our example, we went totally primitive, and used Ug and Gu, a hunter who needed a spear, and a spear maker who needed meat, and who came to mutually agreeable arrangements.  Today we’re going to give a more up-to-date example, and then a proposal to extend the concept to everyone in an economy, then the world.

Back in the Great Depression of the 1930s, Louis O. Kelso observed that, in a country where there was plenty of productive capacity and lots of people who wanted food, clothing and shelter, as well as a few of the amenities of life, there were people out of work and starving.  For whatever reason, people who were ready, willing, and able to work were unable to connect up with the means to be productive, while at the same time, there were people with the means to be productive who were not connecting up with the people who needed to be productive.


The Keynesian solution to all of this was to undermine the U.S. currency, flood the country with funny money (i.e., de facto counterfeit money backed only by government debt) and produce useless goods and services for the sake of creating jobs for the poor and accumulate savings for the rich.  The rich would presumably create more jobs by investing in new capital, which would create the “environment” within which jobs would be created, thereby ensuring universal and eternal prosperity.


It didn’t work out quite that way.  The rich got richer, the poor got jobs for a while . . . and the flood of funny money triggered a “depression within a depression” that didn’t end until the United States started gearing up for the Second World War and there was a customer with purchasing power for everything that could be produced.

The simple fact was the Keynesian economics tried to solve two problems and failed miserably at both of them.  This is despite the fact that to this day Keynesians, post-Keynesians, and socialists of every variety continue to insist that the Keynesian/Fabian New Deal saved the world and ended the Great Depression . . . even though it lasted twice as long as the previous two Great Depressions, those of 1873-1878, and 1893-1898, and we can’t seem to get out of the cycle of boom and bust — or end the incredible and growing income and wealth gap that is bringing the world to the brink of disaster.

Dr. Harold G. Moulton


Remarkably, there was one alternative to the Keynesian/Fabian New Deal that had the potential to solve all the problems except on, and even that one would have been lessened in severity, at least for a few decades.  In 1934 and 1935 Dr. Harold G. Moulton, president of the Brookings Institution, and a team of other experts, published a four-volume study, Distribution of Wealth and Income in Relation to Economic Progress.  The volumes were published in an order that suggested an extended presentation of Say’s Law of Markets, although that was never mentioned: America’s Capacity to Produce (1934), America’s Capacity to Consume (1934), The Formation of Capital (1935) and Income and Economic Progress (1935).

The first two volumes demonstrated that America’s productive capacity was completely intact, but there was insufficient consumer demand to warrant increasing production.  The second volume, not unexpectedly, demonstrated that there would be plenty of consumer demand if those who were unemployed could find work or other ways of being productive.

No surprises so far.  It was in the third volume, The Formation of Capital, that Moulton devastated the Keynesian prescription of creating funny money to stimulate demand.  Correcting the Keynesian prescription, Moulton demonstrated — directly contrary to Keynes’s assumption that consumption must be reduced and surpluses accumulated to finance new capital — that throughout U.S. history, periods of rapid capital formation and economic growth had been preceded not by reductions in consumption, but by increases!

Keynes was wrong.


This created a paradox within Keynesian economics.  If, in every case, periods of rapid economic growth had been preceded not by saving, but by spending . . . where did the funds for new investment come from?  According to Keynes, what the facts showed of economic history could not possibly have happened . . . yet it did in every single case!  In other words,

Keynes’s entire prescription of how to fix an economy was based on a demonstrable falsehood!

But if people were spending instead of saving, where did the money come from for new capital formation?  Printing of counterfeit funny money the way Keynes insisted, and Congress is still doing almost a century after Keynes said it was a temporary measure?


Signing the Bank of England Charter, 1694


Funds for new investment came from the same source they had since the beginning of the Financial Revolution in 1694 and the founding of the Bank of England as the first true central bank: expansion of bank credit for productive purposes.  The U.S. financial system was, in fact, designed to do precisely that: finance growth not with past reductions in consumption, but with future increases in production!  There need never be a lack of funding for any financially feasible productive project.

What Keynes insisted must be the case, that wealth must be concentrated in as few hands as possible and controlled by the government, was exactly the wrong prescription.

. . . except for one thing.  Moulton failed to figure out a way in which ordinary people could participate in, and benefit from economic growth financed with future savings instead of past savings.  In Income and Economic Progress, the fourth volume of the series, Moulton suggested a number of ways to increase consumer income, but it all boiled down to either redistribution or raising wages and thus costs, resulting in inflation.

As a result, the Keynesian solution of creating massive amounts of fake money backed by government debt instead of private sector hard assets was extremely attractive to politicians who wanted to be reelected.  They didn’t have to resort to the old method of buying votes with their own money.  Instead, they could use newly created government money . . . and the people would pay for their own bribes with inflation and loss of economic power and political sovereignty!

Then Louis Kelso had his breakthrough, which we will cover in the next posting on this subject.