Lesson VI – Some “Orthodox” Solutions
As we saw in the last lesson, one of the major economic problems of the present day, and one that is likely to become more and more acute as our “tools” become more and more efficient through automation, is to achieve a balance between the rate at which consumers receive incomes to spend on the goods and services that Industry provides for them, and the actual rate of flow of goods and services onto the market for sale to those same consumers.

Before the Depression of the 1930's, the idea that there might be any kind of imbalance of this kind in the economic system was reserved for economic “heretics”, particularly, of course, the Social Credit followers of Major C. H. Douglas. The onset of the Great Depression, however, showed all too clearly that there was no automatic balance in an economy between ability to produce and ability to consume. The plain evidence of “poverty amid (potential) plenty” of those days forced a decided shift in economic thinking which in fact accepted for its own many ideas earlier put forward by Douglas. This was particularly evident in the writings of Maynard Keynes, whose “General Theory of Employment, Interest and Money” superseded some of the same writer's own earlier ideas on the subject, and paved the way for a “new” economics in orthodox circles that has all but superseded the “classical” economics of the nineteenth and early twentieth centuries.

The “orthodox” economics of today, therefore, is different from the orthodox economics of the days when Social Credit was first propounded. Indeed, most economists of today would agree with many of the criticisms Douglas made of the orthodoxy of the 1920's when first he wrote. Today's followers of Keynes, however, generally consider that the solutions he advanced for the economic problems of the depression – chiefly consisting of low interest rates from the Central Bank and allowing budget deficits as part of a deliberate policy to stimulate the economy – are sufficient to bring about a satisfactory resolution to an economy in recession. It is the purpose of this lesson to analyze the defects in our economic machinery caused by our present system of a bank created money supply in more detail, show how the Keynesian proposals do to some extent act as a palliative, but also show the limitations of those policies, and how alternative policies such as those advocated by Social Credit provide a better solution.

The Layout of the Economic System
In the last lesson, we saw how the creation and withdrawal of bank created credit at first caused a tendency to inflation, which would be followed by a tendency to deflation. That is, at one time, consumers would be receiving incomes faster than goods and services at normal market prices were coming onto the market for sale, and later, goods and services would reach the market faster than incomes were being distributed, and therefore could only be sold, if sold at all, below cost and at a loss.

We will now need to study, not simply the quantity of bank credit that is created, but also the manner in which it is introduced into the economic system, as this has a direct effect on the two most obvious effects of an economy stabilized by “Keynesian” policies – the constant inflation of prices, and the persistent growth of Government and Consumer debt, and the cost of paying interest on it.

When we study an economic system, we are really studying only two things. We study people's wants, and we study the means they use to satisfy those wants.

In a very primitive economy, people look after the satisfaction of their own individual wants – they use their own hands, or those of their family or clan, to produce the food they put in their mouths. In an advanced economy such as our own, people generally work for a “business”, which uses their work and other factors (such as machinery and natural resources) to make goods and services which are placed on the “market”. Those goods and services are then purchased and made use of by consumers, using the money they have been paid for the contributions they have earlier made to the productions of the business community.

Some of the goods and services that business produces, of course, are not for immediate consumption – they are tools or infrastructure to be used up only over a period of time, to aid in making other goods for consumption. Conversely, some of the goods and services coming on the market reflect not simply the cost of the wealth used up immediately in making them available, but also the cost of the capital accumulated in the past, now made use of in bringing this wealth to a marketable state.

We can state that in any period of time, the prices of consumer goods being sold on the market equal “A” plus “B”, where “A” represents those costs, such as wages, sales taxes, profits and so on, charged into the prices of goods, and circulating within a very short period of time back to consumers (Government being regarded as a Consumer, which, of course, it is), and “B” represents those costs, such as for the use and depreciation of capital, which are not balanced by immediate payments to consumers, but are used for the repayment of debt, or possibly “ploughed back” through the capital market to pay for the creation of new stocks of fixed capital.

Suppose, just as an example, that at a particular time there is no need for any capital expansion in an economy. Suppose, say, that we are at the end of a capital investment “boom”, and our business capacity is sufficient for our needs for some time to come. What will happen?

All that part of consumer prices which consists of “A” costs will continue to circulate to business and be paid out by business again in various forms of consumer income, so that consumers receive income at least at this rate. But all that part of consumer prices that consist of “B” costs will be channeled back into the capital market, and, in the absence of opportunities for new investment (which we have assumed) will almost inevitably be used for the repayment of bank indebtedness. And since, as we have seen, it is primarily the borrowing of credit from the banking system by business that causes the creation of the major part of our money supply, this situation will cause a sudden and violent shrinkage in the total supply of money – reflected very quickly in a collapse of prices in the Stock Market and elsewhere. If this creates a panic among consumers, so that they refrain from investing and repay their own borrowings, this will tend to make the situation even worse. C. H. Douglas describes the situation as follows:(1)

“The rate of flow of purchasing power to individuals is represented by A, but since all payments go into prices, the rate of flow of prices cannot be less than A plus B. Since A will not purchase A plus B, a proportion of the product at least equivalent to B must be distributed by a form of purchasing power which is not comprised in the description grouped under A.

“The above proposition is perhaps most simply grasped by recognizing that the B payments may be considered in the light of the repayment of a bank loan by all the concerns to whom they are made, with the result involved in the relationship previously discussed between bank deposits and bank loans. When real capital (i.e. tools, etc.) is financed from savings, that condition is complicated by (b) . . .

“(b) since money is normally distributable only through the agency of wages, salaries and dividends, it being assumed that the interest on Government loans is provided by taxation, the whole of these wages, salaries and dividends must have appeared in the cost and consequently in the price of the articles produced. It does not appear to need any elaborate demonstration to see that any saving of these wages, salaries and dividends means that a proportion of the goods in the prices of which they appear as costs, must remain unsold within the credit area in which they are produced.”

Mitigating Factors
Sometimes it is assumed, wrongly, that the economic problem described above means that automatically, and in all times and places, consumers do not have sufficient purchasing power to pay for the consumer goods that are at that time for sale. This is not the conclusion that Douglas reached, and it certainly is not borne out by experience. Rather, the conclusion to be reached is that, unless there is some compensating flow of purchasing power to consumers to balance the “B” costs that are continually being included in prices, then flowing back to the capital market and so to the banks for cancellation, a situation of deflation and economic collapse will be reached.

This compensating flow is made, under current arrangements, in a number of ways. The following are the most important:

Accumulation of business inventories. The more business accumulates stocks of unsold goods, and finances their production by borrowing on the capital market, the more consumers will be receiving incomes not balanced by increases in the prices of the goods sold to them. A decrease in inventories, of course, has a reverse, deflationary effect.

New fixed capital formation by business. Creation of new capital assets – houses, machinery, office buildings, etc. financed by business borrowing - means that funds are again channeled by means of wages, etc. to consumers without any immediate increase in the monies at that time to be recovered in prices from consumers.

A surplus of exports. If exports exceed imports in price, the result is a trade “surplus”, financed by funds flowing from the capital market to purchase the debt of the foreign nation, and thence to pay for the goods sold by the exporter. Again, this means that funds from the capital market flow to business, and from there to consumers in additional wages, without any comparable increase in the goods and services placed for sale on the domestic consumer market.

Personal Debt. If the public at large, instead of placing funds for investment on the capital market, so reducing their power to buy consumer goods, borrows instead, and so receives funds from the capital market, (e.g. by buying automobiles “on time”, buying houses with large mortgages against them, and other forms of credit purchase) then consumer purchasing power will again be increased without any immediate increase in the costs that business will have to recover in the price of what it sells.

Government deficit finance. Government borrowing on the capital market, when such monies are spent into circulation either in direct purchases, or indirectly by payments in pensions and so on, has this same inflationary effect. It is this attempt of governments to prevent deflation by spending beyond their own incomes and borrowing the difference that lies at the root of deliberate deficit financing by government in time of depression for the purpose of getting the economy moving once again.

Unnecessary Capital Development. An excessive pressure to develop megaprojects to support the people's style of living is encouraged, not for the purpose of the actual need, but to keep people at work so that they will receive incomes. A serious consequence of this is strain on the world's ecology, where reasonable limits on development projects are resisted because of the unemployment that will result if they are discontinued.

War. If the struggle for markets, or the need to cure unemployment at home, gets too oppressive, then War becomes a solution. In times of war, ordinary financial rules are suspended, enormous debts are run up to pay for soldiers' salaries and war material, price controls are often imposed to prevent inflation, and a stagnant economy is transformed to one of incredible productivity – for destruction. The enemy is not expected to pay for the bombs and bullets delivered to him, and without that financial limit, the only limit on production is a physical one. The tragedy is that the wealth that is being used up in hostilities could so much more usefully have been made available for international aid and to relieve poverty both at home and abroad.

The Resulting Situation
Let us summarize these influences at work in our economic system. The fundamental problem, arising directly from the use of bank credit in business financing, is that there is no built in balance between the rate at which consumer goods and services become available for sale, and the rate at which consumers receive incomes to buy them. A business's cash flow will almost always be different from that same business's profit and loss statement. The system therefore swings in cycles from inflation to deflation.

Inflation can be attributed to two basic causes. One is the familiar one of “too much money chasing too few goods”, which accompanies wartime financing, or times of rapid capital development and/or consumer debt financing, the result of increased lending of Bank created money. The second, is the fact that businesses cannot sell below their costs of production without heading towards bankruptcy. Consequently, in a period of tight money, when sales become difficult and prices would otherwise be driven down, businesses will frequently attempt to cover their costs by reducing output and increasing their prices – something pointed out in an earlier lesson (2). This involves a very harmful situation of both inflation and economic stagnation – sometimes known as Stagflation, familiar to us in particular from the history of the early 1980's.

The most basic tendency is a tendency to deflation. By this is not meant that there is always a shortage of money relative to the supply of consumer goods. It means that unless the economy is being continuously stimulated by one of a number of devices – export surpluses, new capital development, government or personal borrowing or the like – it is on the brink of having a large part of its money supply canceled, and a situation arising where incomes are not enough to pay the necessary prices of goods offered for sale, with consequent poverty and distress in the midst of potential plenty. No wonder there is such an underlying tone of nervousness in the statements of all who are responsible for forming or commenting on the nation's monetary policy. No one can ever be sure, as things are at present, how long “good times will last”.

Let us assume, though, that conventional monetary policy is working as well as it can under our present monetary system. Will that be good enough? What can we expect?

Firstly, we can expect a system where the ownership of business is not in the hands of ordinary people, but a large part of business assets are balanced by borrowing of business from banks, not from private investors. To this degree the average citizen is prevented from receiving the dividend income he should be relying on more and more in this age of developing automation, and the problem of personal poverty in an age of abundance is made that much the worse.

Secondly, we can expect governments and peoples to become progressively more in debt. To buy the wealth he has produced, the wage earner is obliged to borrow – if he does not, demand for his product falls, and he will find himself out of a job without a wage income at all. Both taxes and personal living costs increase as a result of the burden of interest that this progressively greater debt involves. In the end we may find a people who, apart from a privileged few who are on the “inside track” (and incidentally therefore have a great deal of political influence to prevent change), have no property or possessions they can call their own, and a government at the mercy of its, and the people's creditors.

Thirdly, we can expect a people in a chronic state of unnecessary anxiety about their own economic future. From the material point of view, there is not the least doubt that Canada is rich enough to support all of her population in the foreseeable future in a very fair degree of comfort. But from the point of view of finance, it is more than likely that some time in the foreseeable future such a financial collapse will come about that many able bodied Canadians will lose their jobs and because of this go short of the necessities of life.

Fourthly, we can expect Waste in our economic system, as political expediency brings pressure on governments to instigate or guarantee “make work” projects for the purpose of distributing incomes through employment – these works usually being of a capital nature, of course, to satisfy some imagined demand in the future and not to provide consumer goods, because of the difficulty of finding consumers with money to buy such products by cash payments through free choice on the market.

Fifthly, we can expect chronic slow inflation of prices in our economic system, if the effect of these stimulants distributes incomes faster than consumer goods reach the market for people to buy. This in addition to the constant addition to business costs, and therefore prices, caused by taxation to cover an ever increasing National Debt.

Sixthly, we can expect tension in international trade, as every nation seeks to improve its own economy at home, by protectionism and trying to export more abroad than it imports from abroad – a mathematical impossibility.

Seventhly, a “race to the bottom” in the quality of consumer goods on the market, aimed more and more at a public that is under financial pressure to buy in the cheapest possible market – even if it means buying products produced in intolerable conditions in third world countries, which are displacing employment at home.

Eighthly, a loss of personal freedom, as competition for sales drives wages down, leads to layoffs and unemployment, so making the poor poorer, sometimes having to work two jobs (if they can find them) in order to earn a living income. Investment money may be cheap and easy to come by – but because business conditions are so bad, nobody wants to borrow it. In fact, if prices are falling rapidly even a low rate of interest makes the cost of borrowing prohibitively expensive.

So in coming lessons, we will be examining some of the ideas that have been put forward by reformers in the past, to eliminate these defects.



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QUESTIONS:
1. Is there any difference between the rate at which consumers receive incomes, and the rate at which business is seeking to recover costs through sale of goods on the consumer market?
2. If so, what are the effects of this:
(a) Where the flow of consumer incomes in greater than the rate of flow of business costs?
(b) Where the reverse is the case, and costs exceed incomes?
3. If the production of new capital goods were suddenly to come to a standstill, what economic effect would you expect?
4. Name some of the most important causes at work causing inflation in an economy, and explain their effects.
5. Name some of the most important causes at work causing deflation in an economy, and explain their effects.
6. Define “Stagflation” and outline its causes.
7. List some of the principal solutions to these problems made use of in our present day financial system, and the problems attached to each..



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FOR FURTHER READING:
R.N.Thompson “Canadians, It's Time you Knew”; “Commonsense for Canadians”.
J.M.Keynes: “General Theory of Employment, Interest and Money, Chapters 22 (Notes on the Trade Cycle) and 23 (Notes on Mercantilism).
J.M.Hattersley “A New Way Forward” Brief to the Royal Commission on Canada's Economic prospects.


Sources:
(1) Monopoly of Credit, 1951 edition, page 141
(2) Study Course in Social Credit - Lesson IV.