“Which one of those things is it?”
“Well—when you come right down to it, I guess money is gold.”
“That’s what J.P. Morgan thought, at least he told a Senate committee that in 1912. I wonder whether he was lying or deluded. Try this definition: ‘Money is anything which can always be swapped for goods, or services.’ I believe that you will find that to be the only characteristic common to all money, and common to nothing else. How much money does a country need?”
“How can anybody answer that question?”
“Apparently nobody tried to before the present economic regime. Money was expanded and contracted in a most senseless fashion. The panic of 1907 for example was produced by a deliberate contraction of money. But the answer to the question is simple, and arises from the nature or purpose of money as we defined it. A country needs enough money to enable its citizens to perform all desired exchanges of goods and services. Your 1939 system did not accomplish this; our 2086 system does.”
“But look—there was plenty of money in 1939. That doesn’t make sense.”
“Haven’t you just told me that in 1939 there were millions of people who needed things they couldn’t buy? And weren’t there merchants who had all these things and wanted to sell them very badly, yet couldn’t sell them? Wouldn’t all this have been very different and vastly improved if the people in dire want had had that money in their pockets to buy from the merchants who had to sell or go bankrupt? Isn’t that a shortage of money?”
“Yes, of course. But where are you leading me?”
“Patience. In 2086 the government gives money to the people to do that necessary buying.”
“Yes, I know. Master Cathcart told me that the government got this money off the printing press or out of the inkwell—in other words fiat money. How can it be worth anything?”
“We decided that money was anything which always could be swapped for goods and services. That implies that the person who accepts it believes that he can do likewise. Therefore money is money as long as everybody believes it is money. There is a touchstone which will enable you to determine whether or not people will believe in money: Can you use it to pay taxes? Will the government give you something for it of value, postal service for example? If the people collectively as a state will accept it, then so will the individuals. Our ‘fiat’ money qualifies. The United States will accept it in exchange for things of value. That is no longer true of your gold. It can’t be used for taxes. You may or may not be able to swap it off, it isn’t money, and you may be stuck with it. As a matter of fact all United States currency has been ‘fiat’ currency ever since the United States suspended gold payments in 1933. Since that time the gold standard has been simply a fiction convenient in party politics. However I believe that your principle difficulty is in understanding why it is necessary for the government to create new money and give it away to the consuming public. In order to understand that, it is first necessary to understand the mathematics of the relationship between prices and purchasing power.
“Before we go into the mathematical theory, let me state the fact which we are to explain: In 1939, and before, the sum total of the purchasing power of the public was always less than the total price of the goods offered for sale. This is just another way of saying that ‘overproduction’, with its attendant unemployment, poverty, labor warfare, and so forth, was a chronic condition. As a matter of fact it is not necessary to understand the mathematics behind it as long as you observe the fact, just as it isn’t necessary to know how a house caught fire in order to see that a house is on fire and to realize that something must be done about it. I stated that ‘over-production’ was chronic and that it is identically the same thing as saying that the public as a whole didn’t have the money with which to buy the goods offered for sale. You will certainly agree that such was the condition from 1929 to 1939. It was generally recognized and the government even went so far as to partially make up the spread between prices and income by direct relief—giving money away—and wages for made work—giving money away with a moralistic sugar coating. This would have been sensible had the government created the money by fiat. Instead they borrowed it from the banks who created it by fiat. This was silly as it piled up a national debt to be reckoned with in the future and the money wasn’t one whit sounder under the fiat of the banks than it would have been by government fiat. For please understand that the money lent the government by the banks to provide relief did not come into existence until it was borrowed. The bankers took it out of an empty vault—they fished it out of the inkwell. This may be hard to believe but it is the literal truth. Every time a bank loaned money in those days it created it. Of course President Holmes would successfully reclaim this practice for the government decades later, but at this time it was entirely imprudent.
“But to return to ‘over-production’. Before 1929 in the period after the World War until the market crash, the spread between production and consumption was absorbed in several ways; an enormous increase in private credit or debt especially in the development of installment buying, exploitation of foreign fields particularly in Central and South America—which means to give away goods and get engraved paper in return, which later turns out to be worthless; and in losses suffered by practically all farmers and many businessmen. You see, a large percentage of businesses failed even in boom times in which case their inventories were sold below cost.
“The condition in the World War years is simple to understand. During war, production goes at maximum speed for the war machine and burns up the excess. Of course an enormous load of debt is created which must someday be cancelled in some fashion. Before the World War there were many years in which the pattern was similar either to the boom twenties or to the depression thirties. In either case production always ran ahead of consumption and was disposed of in the usual ways; by the creation of debt, by destruction of price values through bankruptcy, by sending more goods out of the country than were taken in, or by outright destruction of goods as in war, or, as was done in peace time, by crop destruction.
“The case in which more goods are shipped out each year than are imported deserves special mention. For many years this was regarded as the ideal economic condition although any child can see the absurdity of it, but it was called by all sorts of fancy names; ‘Favorable Gold Balance’, ‘Favorable Trade Balance’, ‘The American Plan’, ‘Cornerstone of American Prosperity’. It was taught in the public schools as a natural law.”
“Yes,” mused Perry, “I remember being taught that in grammar school. My geography book devoted a whole section to telling how necessary it was.”
“As a matter of fact it was as vicious as it was silly. Each nation tried to sell more than it bought, and this was the basic cause of every war in modern times. The stupidity of the idea should have been obvious, but the nature of the financing system made it inevitable. Since production always exceeded consumption by a wide margin throughout this period,4 it was necessary for a nation to get rid of its excess as best it could or suffer severe economic upset at home. Many were the devices to promote this, for example, the ‘protective’ tariff and the subsidizing of the merchant marine.
“There was only one period in which this peculiar financial fallacy was suited to the needs of the country, and that was in the days of the frontier. The system created bankruptcy and poverty, and the victims moved west and developed the country. It is customary to speak of population pressure as causing the movement west, but that is true only in a limited sense. The east was never too crowded in the pioneer days to support its population insofar as land and raw materials were concerned, but it already had a financial system which automatically created a spread between purchasing power and production, and thereby automatically created an unemployed class, which moved west with the next wagon train to rehabilitate itself in a simpler economy. Oh yes, we had an unemployed class in Andrew Jackson’s day, but we called them pioneers!
“So much for the si
mple fact that in your 1939 economic system over-production or under-consumption or a shortage of purchasing power was a chronic condition. Now let us examine the mathematical nature of purchasing power to discover why this was so. In so doing we shall discover the possible solutions and select the one we like. You see I’ve done this problem before and can show off how clever I am. You know about Little Jack Horner? I’ve always suspected that he knew where the plum was before he stuck in his thumb.” A grin split Davis’ saturnine visage and made him look like a little bald-headed gnome.
“Consider, if you please, two typical units of production, a factory and a farm. Let the factory be large, an employer with many employees; let the farm be small, a one-family affair. These two cases will be typical—insofar as price and purchasing power are concerned—of the entire economic organism. First, the factory: It makes, let us say, shoes. These shoes are placed on the market at a definite price. This price consists of two parts; the cost to the owner of the factory of making the shoes, plus a profit. The cost consists of a number of items, of which the principle are wages to employees, cost of raw materials, depreciation on capital goods, rent of land, interest on invested capital, and taxes. The additional portion of the price is the profit. This is the return to the owner or entrepreneur for his time, personal labor, ingenuity, and so forth, and is the source from which he must support himself and his family. To assume that profit is unnecessary is to assume that employers don’t eat. It was popular in your day to attack the ‘profit system’. We shall see that profits to an entrepreneur are not the cause of unemployment and financial distress. Of course there will arise the question of some entrepreneurs receiving a disproportionate amount of production as their profits, but that is a question of morals to be regulated according to the current customs. It does not in itself cause unemployment, as we shall see. As a matter of fact most persons who undertake the enterprise of new production, or entrepreneurs, did not make an excessive profit; most of them made no profit and went bankrupt. That is a simple matter of record. In your day eighteen out of nineteen businessmen failed in the long run. The groups who attacked the ‘profit system’ were beating a dead dog.
“Nevertheless, since entrepreneurs must eat, profits are a legitimate part of the cost of production. Henceforth we shall include them as cost charges and consider that the necessary value of an article of production is its total cost, or cost to the entrepreneur plus his necessary profit.”
Perry interrupted. “Do you mean to say that the profit system in my day was okay? It seems to me that the profit system was always being attacked as the villain in the piece.”
“The profit system was not the villain in the piece. The villain was ignorance of the workings of the economic mechanism, in which the entrepreneurs or industrial leaders were the greatest offenders. At the very least the laborers knew that something was wrong and demanded a change, but the industrial entrepreneurs denied that any change was needed, and stubbornly resisted change with the ignorant willfulness of a Marie Antoinette. Furthermore they possessed the economic and political power to resist change. In that way they were the villains and were responsible for all the tragedy of your era. But let’s not condemn them too heartily, as they were ignorant and stupid rather than innately vicious.
“But now let’s prove the statements I have made. Let’s put this factory into operation and see how a cycle of production and consumption works. I mentioned a shoe factory. That will give us too limited a case to understand the whole industrial system. You understand the mathematical principle of the general case, the one in which all possible factors appear. Consequently any individual problem can be solved if you can solve the general case. Of course you do, very well then, let this factory be the general case of any production unit in the country which employs labor and uses capital. Its raw materials will be the materials it processes even though those materials have previously been processed after leaving mother earth. Thus steel plate or tanned leather may be termed raw material for automobiles factories and luggage factories. The term factory includes buildings and chattels of every sort used in production but which are not themselves the goods produced by the factory. Land includes the sites of buildings, rights of way, and so forth. Do you follow me?”
Perry nodded. “Sure. It’s like any algebraic general case, like the general quadratic equation for instance; ax squared plus bx plus c equals zero gives a general solution of x equals negative b plus or minus the quantity the square root of b squared minus four ac all divided by 2 a. Substituting the conditions of a particular case gives the answer for that particular case.”5
“Exactly. Let’s set up the general case of a production-consumption cycle under the rules of your period and work out a few problems. Then perhaps we shall see the principles involved and be able to state a general solution which will answer all our questions about economics.”
Perry scratched his head. “Look. That’s all very well in simple algebra like quadratic equations, but in economics we deal with an indefinite number of unknowns and too many factors. How can we possibly do this?”
“We’ll cross that bridge when we come to it. All special cases in the actual world are complex, it is true, even in quadratic equations. But the general case may turn out to have pleasing simplicity. Let’s try to formulate it, and see. Have you pen and paper? Let’s write down our elements. What are they?”
Perry thought. “A factory.”
“Yes.”
“The entrepreneur or industrialist.”
“Go ahead.”
“Raw materials, and labor, and land.”
“Continue.”
“Consumers.”
“That is right, but who are they?”
“Everybody. All of the public.”
Davis nodded. “True, but this is the general case. What does that imply?” Perry looked puzzled. “I’ll tell you, then. The consumers are the people you mention plus their dependents, and no others. Even retired people enter the picture as capitalists or dependents, as well as consumers.”
“Yes, I think I see that.”
“Each individual has a dual role, appearing both on the production side and on the consumption side. Even a child appears as a producer through his father and appears as a consumer of goods purchased by his parents. We can disregard dependents from here on as they are represented economically by the head of the family.”
“How does a widow living on insurance appear in the set up?”
“As a consumer of earlier production of the deceased head of a family. We’ll take that case up later when we are ready to deal with it. Let’s get on with our set up. What else do we need?”
“A bank or banks.”
“Yes, and bankers, stockholders, bank clerks, and so forth. Will you let me lump them together as a bank and a banker, remembering of course the collective nature of the terms?”
“Okay, I guess.”
“Very well, then. Do we need anything else?”
“Not that I can think of.”
“Was the United States an anarchy?”
“No, of course not.”
“Then we have the government, and all of the subdivisions of government, public servants, taxes, and laws, and the government as a consumer.”
“This grows complicated.”
“Not too complicated. Let’s represent government, and all subdivisions, as ‘US’, which you can think of as ‘United States’ or as ‘us’, for in the United States the government is everybody taken collectively. Public servants work for ‘US’. Now do we have all elements?”
“How about farmers and professional men? They are certainly consumers.”
“Yes, that’s true. The case of the farmer is simple. Economically speaking, he produces in the same fashion as the factory owner, using the same elements; labor, raw material, land, enterprise, and so forth. If he employs no labor but himself and his family, ‘profit’ should appear as a large item in cost, and labor wages as zero. It becomes simply a s
pecial case under the general case. The professional man appears as a different type of laborer when he is hired by a production unit, for example corporation lawyers. Professional men serving the consuming public directly appear in the production-consumption chain in a one-to-one relationship of transfer without destruction of purchasing power. When you pay a medical man ten dollars for advice, your potential power to purchase and consume doughnuts or automobiles is reduced ten dollars and that of the doctor is increased by ten dollars. There is another element we have not named however. Can you guess it?”
“Mmmmmn—no, I’m afraid not. It seems to me we’ve covered the—Wait a moment. Technique! Knowledge.”
“Exactly. Most knowledge is free to all of us. But some things are patented or copyrighted. Let’s call the owners of techniques inventors. Now we are ready to roll. If we set up our hypothetical domestic economy so that it is structurally similar in every way to the economy of your period, it should work like your period. If we change the man-made laws to those of this present period, it will work like this present period. The natural laws involved remain the same structurally. If we can distinguish between man-made rules and natural necessity, we will know what we can and what we can’t do with an economic system.”
“How can we make any such complicated set up in our heads and be sure that it will work out in practice, Master Davis?”
“I shan’t ask you to carry all of the moving elements of a complicated function in your head. Let’s make a model. I see a set of chess men over there. May I use them? They will do nicely for people. Now have you anything I can use for counters?” Perry rummaged around and produced a box of poker chips. “Gaming chips? That’s fine. Now we need something to represent the goods we are to produce and consume. What do you suggest? I’ll need a number of units, a hundred or more.”
“How about a box of crackers?” suggested Perry.
“A happy thought. Distinctly consumption goods. But we would get crumbs all over the table and they are rather bulky. Do you have any playing cards?”
For Us, the Living Page 17
