"Why, I come out even I suppose."
"Do you? Last time you spent forty-four shekels on wages and thirty shekels on materials to build sixty-three playing cards. How much do you spend this time?"
"Let me see. Forty-four and thirty is seventy-four. The labor and materials cost per unit is one sixty-third of that." Perry set it up on his slide rule. "It comes to one point one one seven five (1.1175) shekels per card. I'm producing fifty-five cards this time. Fifty-five times one point one seven five is sixty-four and seven-tenths shekels."
"Those people bought thirty-seven cards with their seventy-four shekels last time. What can they buy this time?"
"Thirty-two and a fraction."
"Exactly. You sell your best market five fewer cards than last time. As a result of doing the only reasonable thing, you have more cards left over than before, you've thrown some people out of work, you have created less real wealth for the community to use and you are even farther from being able to pay off your note at the bank for you now owe one hundred and eight shekels and have only ninety-one with which to pay."
"Ninety-one? I figured ninety-two."
"No, ninety-one? Perhaps you forgot that your interest is eleven shekels on a hundred and eight."
"That's right. I figured ten, like last time. Now what happens? It looks like I'm going broke."
"Wait a bit. Do you see what caused the original 'overproduction'?"
"Why yes, the banker got money out of me that he didn't turn around and spend with me. Everybody else spent their money as it came in."
"Then what's the trouble?"
"Well, it looks to me as if it was the interest you expected me to pay. If I hadn't had to pay you that interest I'd have come out even."
"Not so fast. They weren't exactly equal and could not therefore have been the same thing. Even bankers have to eat. Why should he run a bank if he isn't paid to do it? Tell me, what would the effect have been if anyone else had saved part of his income instead of spending it?"
"Ohhhoh!" Perry slapped his thigh. "I see! If anyone saves income that he receives from the cycle, it is thrown out of balance and over-production results."
"Exactly. In the problem that we have just gone through I cast the banker as the thrifty villain simply because banks were the worst offenders. They charged as much interest as they could get, and spent very little on consumption, whereas the workers, by and large, had to spend all they got as they went along. But all were guilty of the economic crime of not spending all their purchasing power and thereby saving themselves into bankruptcy, even a father with his life insurance policy and baby with his penny bank."
"Wait a minute, Master Davis. It seems to me that money saved eventually finds its way back into purchasing, even after several years. It all balances out in time. There should have been some consumers spending their savings in that first cycle to make up for those who managed to save."
"There were, of course. If savings are actually tucked away in a sock, it doesn't do much harm. It balances out with just a small carry over of inventories. But most money is not saved that way. Ordinary people invest in life insurance and savings accounts. Industrialists and financiers put it into capital expansion—use it to increase production. In each case it goes into new production."
"But how can that be harmful? We have just shown that money used for production creates new purchasing power to buy the goods produced."
"That's true but you are looking at just one part of the picture. Listen to me carefully. This is the crucial point: Potential purchasing power not spent for consumption but saved and invested for production in a later cycle has appeared as cost in both cycles. When it reappears as purchasing power in the second cycle, it is needed there, and still leaves the first cycle out of balance. For example, if money saved out of your playing card cycle were saved to finance a jelly bean production cycle every shekel of it would appear as cost in the jelly beans and would be needed to purchase jelly beans. It's not available to buy playing cards. To make this exposition rigorous I should mention the possibility that capital funds are occasionally spent on consumption and that money is sometimes taken out of production entirely, but this also produces unemployment and its attendant evils. The Panic of 1907 was of this nature, artificially created by the Morgan Bank and associated interests.
"But let's get back to your playing card factory. It is in trouble. These cycles continue. Each time the bank owns a bigger piece of your business and more of your employees are out of work. Eventually they are in dire distress and private charity cannot carry the load. Congress provides relief. At first Congress tries to pay for relief with new taxes but you business men howl that you are losing money now, which is true. Taxes on everybody—such as the sales tax—rob Peter to pay Paul, and increases purchasing power not a whit. It helps a little to tax the higher bracket incomes but in the long run that inhibits production by striking at a source of capital expansion. Congress is forced to look elsewhere for money to subsidize purchasing power and provide relief, for the spread between production and purchasing power has grown enormous, more than thirty percent in your day, billions of dollars a year. Some congressman from the middle west who cut his teeth on the Bryan campaigns proposes that the government print greenbacks to provide relief for the unemployed, but the bankers condemn this as 'unsound', 'inflationary', 'radical', 'striking at the roots of our institution'. They have great political power and carry their point. There is but one thing left to do and the government does it. It borrows for relief from the banks. True, the banks have very little cash money but the same law that permitted them to lend you money out of the inkwell enables them to lend to the government with the whole United States as security, the security being represented by interest-bearing tax-free bonds. The national debt climbs sky high but the system is held together a few more years, until the banks own practically everything, even the government."
Perry ran his hand through his hair and whistled. "You paint a pretty bleak picture. What is the answer?"
"We undertook to set up a general problem which, when solved, would answer the question in all cases of 'How much money does a country need?' We set up the general production-consumption cycle and worked through some problems under the conditions of your period. We should now be able to work the problem in general terms to arrive at the general answer. I believe you could do it with a little thought, but I will state the general answer for you to inspect and approve or reject. Here it is:
A production cycle creates exactly enough purchasing power for its consumption cycle. If any part of this potential purchasing is not used for consumption but instead is invested in new production, it appears as a cost charge in the new items of production, before it re-appears as new purchasing power. Therefore, it causes a net loss of purchasing power in the earlier cycle. Therefore, an equal amount of new money is required by the country.
"This money must be a new issue, not borrowed from the banks, for there is no way to pay it back. To tax it back from the country as a whole is to destroy necessary purchasing power at a later date. To tax it back from the bondholders is a polite name for cancellation. But that was necessary and was eventually done, in a roundabout manner."
"How?"
"By paying off the bonds with new money, then getting it back with inheritance and income taxes. There are several interesting corollaries to our main proposition. Here is one, 'No economic system can create its own new capital.' That must be done by the fiat of the sovereign state. The banks can't do it, even when they are permitted to create money, as they must recover the money they create and loan, plus a charge for the service, or 'interest'. Furthermore, banks should not be permitted to create money at all, because they are, of necessity, interested only in making a profit. They will inflate or deflate the currency to make a profit regardless of the monetary needs of the country. Their interest rates are a reflection of an artificially created money market with no relation to the cost of the service. No, banks must be required to
loan only deposits placed with them for that purpose, that is to say, their reserves must be 100%, not 10% as in your day. They must keep entirely separate the funds left with them for commercial exchange, i.e. commercial checking accounts, funds placed with them to invest orloan, and funds deposited for safe keeping. In such a case the customer pays for the service of checking and exchange, pays for the service of safekeeping, and receives interest on funds deposited for investment. But the banker no longer manipulates the money supply of the nation to suit his convenience.
"Furthermore, from what we defined money to be and from our examination of the production-consumption cycle, we reach the important conclusion that there is no necessary one-to-one relationship between taxes and government expenditure. If a country is expanding industrially as the United States has since it was founded, the government is obliged to put out more money than it receives in amount equal to new capital investment in order to avoid deflation. This is new money never received in taxes. In fact the Federal government need not tax at all, except as a regulatory measure. It needs no taxes for revenue. It must never tax as much as it spends or gives away, as long as production is rising. This gives the government remarkable freedom. If a new battleship or a new highway was needed in your day, the economically sound thing to do would have been to go ahead and build, paying for it with new currency. Congress should consider only two things: 'Does the country need this battleship, or road.' And 'Is the country rich enough in manpower and materials to produce it?' If both answers are yes, go ahead and issue new money to do it."
"Just a moment, Master Davis. What is this new money worth, if anything?"
"How do you mean that?"
"Well, in my day money could be exchanged for gold, not very easily, but it could be done. How can one be sure that this new money is anything but pieces of paper?"
"As I told you before, the government will accept it for taxes, and for services such as the postal service. But you want to know what it is worth in terms of real wealth, just as the old style dollar was worth so many grains of gold. Very well. If you present a draft for a thousand credit units or dollar bills to any one of several government warehouses, the bursar will give you an assorted group of basic commodities of weights and standards specified by law."
"Where does the government get these commodities?"
"Grows or makes them, buys them in the open market, and may occasionally accept some of them as taxes."
"That seems awfully cumbersome compared with the gold standard."
"It is cumbersome, but it's worthwhile for it gives a much more nearly stable medium of exchange than gold. As a matter of practice the government keeps very small stocks of commodities because with a stable standard for money the public prefers cash or credit at the Bank of the United States to the trouble of handling bulk in commodities. They are satisfied to know that they can get real wealth in specified amounts, if they choose."
"How about foreign trade? This sort of money would be a nuisance there."
"Gold, as well as platinum, silver, and other convenient commodities, is still used in foreign trade exchange. The government buys and sells these commodities in the open market as a convenience to its citizens."
"I guess that clears it up. It still seems complicated."
"It is, Perry, more or less. But it isn't anything to the anarchistic maze that your old money system was. Let's get back the tax problem. The fact that there is no necessary one-to-one relationship between taxes and government expenditure is startling at first, but is evident from the nature of money. Money in the hands of an individual is a token of a debt to one of us owed by all of us. This token in the hands of the government states that all of us, i.e. the government, owe a debt to all of us, i.e. the government—an absurdity. One cannot owe oneself a debt in any but a poetical sense. Money in the hands of the Federal government is a scrap of paper and ink. It is significant only when held by individuals or groups of individuals.
"We recognize nowadays that Federal taxation is a deflating process, and that Federal government spending is an inflating process. Each process has important secondary effects through which it can be used to regulate for the general welfare. Taxation may be used to prevent unwholesome concentration of wealth. It may also be used to prevent too great a difference in the net income of individuals. The issue of new money is an even more powerful instrument in shaping our economic life to suit our wishes. It is a means of ensuring social security for the entire population through the dividend or inheritance checks. It can stimulate production and prevent inflation of prices through the use of the discount. It is used to assure an equal start for every child. In fact the knowledge of how to use money enables us to inhibit or encourage almost anything without coercion. If we desired, we could institute as near complete a socialism in the United States as we wished, without confiscation and taking over the tools of production. The present set up suits us now. We can change it if we like, when we like, for we understand the economic mechanism. The economic determinism of Marx is an exploded bugaboo, and the American people are the masters, not the slaves, of their economic system."
Davis took a sip of sherry, and looked slightly giddy. "You'll forgive my enthusiasm, I trust. This is my subject and I am sometimes carried away by it."
"I am not surprised," replied Perry. "You have reason. I confess I don't see all those implications just yet, but it sounds amazing."
"You will see," returned Davis, "and by the very method we used. You can set up this game with the chessmen to cover every possible case. For example, throw in some professional men and observe that the cycle is unchanged. Provide a foreign trade with a balance in our favor and see how the cycle can be made to balance. Then a foreign trade in which goods are dumped on us and see how it dislocates our system. Then change the supply to balance it anyhow and observe how we can benefit. Play two tables and let trade flow between the tables. Set up a farm production cycle on one and factory on the other. Throw in corporate organization, trust funds, re-discounted paper, and so forth. Have a labor leader organize the workers and stage a strike. Get a lot of bank credit passed around and then make a run on the bank. Issue stock and watch it fluctuate in market price. Declare war and put industry on a war basis. Inflate the currency. Deflate it. Save your profits to expand your business. Cut prices to meet competition. Get squeezed on your lease. Start out from primitive barter, work up the present system with the dividend, the discount, and the National Account. Do all of those things, but be sure to observe the rule of duplicating the structure of the real world. It's fascinating and you will teach yourself more about money and economics than anyone else can possibly teach you. Bear in mind the fundamental theorem that we formulated about the necessity for new money for capital expansion. If you find any situation which appears to contradict it, or any of our other conclusions, go back and do it over, writing down each step in detail. If you don't find your error, give me a call. But I'm sure you will.*
[*Several typical problems have been worked out for the benefit of the reader and appear as an appendix at the end of the book. A typical modern cycle is given showing the dividend and discount in operation. Especially interesting are examples of twentieth century economics showing the ridiculous impasses into which our forefathers fell simply through failure to understand the nature of money. The Author]
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Perry followed Master Davis' advice and spent several days making up problems to play out with his economic tin soldiers. He drafted Olga and Diana into the game, and they solemnly played through various combinations of financial and economic situations. At first the women played simply to be agreeable, but they became fascinated by the strange possibilities of early day finance. Olga developed remarkable skill in stock market and commodity manipulation, and amassed fabulous fortunes on paper. Diana protested this and maintained that it obviously would be illegal for anyone to do such wicked things with the necessities of life. References to history left her only partly convinced. Di
ana liked to run factories but was a failure as a banker, as she could not see any sense in interest and was reluctant to clamp down on a debtor. Both of them admitted that they had not understood the operations of finance and industry before, and had rather taken the economic regime for granted. Perry found himself in the pleasant position of being able to instruct natives of the new America in the workings of their own environment.
In due course he felt that he understood fully the workings of both economic systems, the old and the new, and felt capable of analyzing correctly any possible economic system. Nevertheless he found growing up inside a curious distaste for the modern system. He now understood the mechanics of it, true, and realized that its mathematical theory was correct, but notwithstanding it did not suit his taste. He decided to call Davis and discuss it with him.
After a decent interval of drink and smoke, Davis opened the conversation.
"What is it, my boy? Found a black swan?"
"Why a black swan?"
"That's the classic example of the fallaciousness of the deductive method. The syllogism ran 'All swans are white. This bird is a swan. Therefore this bird is white.' Along in the nineteenth century somebody found a black swan and the perfect syllogism was wrecked."
For Us, The Living Page 18
