Yes

by Michael Greaney

Created on: September 03, 2010

In 1994 a book came out titled, "Curing World Poverty: The New Role of Property." The book was favorably received in some quarters, ridiculed in others. The favorable comments all said pretty much the same thing, that the proposals sounded good, and it was at least worth a shot. Humanity, after all, has little to lose other than widespread, grinding poverty that has become a virtual epidemic.

It was in the comments of the critics that the most diversity was seen. Negative comments ranged from the merely dismissive (e.g., it can't be done, therefore it's a waste of time even to talk about it) to superficial rejections of the specific techniques suggested, particularly opening up democratic access to the means of acquiring and possessing private property.

On close examination, all of the negative commentators had one thing in common.  Every one of them took for granted the assumption that new capital formation cannot be financed except by cutting consumption, accumulating money savings, and investing.  This assumption is at the heart of the three main schools of economics that have gained center stage today (Keynesian, Monetarist, and Austrian), and have thereby earned the label, "orthodox."  This is appropriate, when we consider that the belief that new capital formation can only be financed using existing accumulations of savings is held as a virtual religious dogma on the basis of faith, not of reason.

The theory is, given existing accumulations of savings are presumably essential to the financing of new capital formation, ownership of the means of production must be concentrated in as few hands as possible, whether a private elite (as in capitalism) or the single "person" of the State (as in socialism/communism).  Poor people who own only their labor do not have the capacity to cut consumption and save.  Many of the poor would be (and increasingly are), absent redistribution of existing wealth through the tax system or inflation, utterly destitute.  With the value of human labor continually falling in value relative to advancing technology, few people can even gain a subsistence these days by selling their labor.

This restricts the ability to save to those who already own capital.  With the hyperproductivity of capital relative to labor, in fact, it becomes impossible for the rich to consume all of their income.  They are "forced" to reinvest the excess in additional new capital.  The new capital generates even more income that cannot be consumed, which is necessarily reinvested in yet more new capital.  In theory, this creates jobs for those who own no capital, but the reality is that, increasingly, technology replaces human labor and fewer jobs are created.  Even the jobs that are created tend to be moved to areas where labor costs are lower.

To correct this imbalance, the State steps in and attempts to "fine tune" the economy.  The trick is to tax away just enough from the rich without causing the rate of capital formation to slow down.  The State then inflates the currency to raise the price level. This forces wage earners to cut consumption and transfers purchasing power ("savings") to producers in the form of higher profits.  These "forced savings" can then be used to finance new capital formation, creating jobs, and increasing effective demand.

The flaw in this reasoning is that this is not the way new capital is financed.  Rather, existing accumulations of savings are rarely used to finance new capital formation.  Given that savings equals investment, the savings are already invested, often in the form of capital equipment on a company's balance sheet, the ownership of which (the amount of savings) is booked as "retained earnings," a fancy word for savings.  Existing capital is typically not liquidated to finance new capital (what would be the point?), but is used as collateral to secure a loan to finance new capital.

As Dr. Harold Moulton of the Brookings Institution demonstrated in his landmark monograph, "The Formation of Capital" (published in 1935 as the third volume in a four-volume set to give an alternative to the Keynesian New Deal for recovery from the Great Depression), relying on existing accumulations of savings is not essential to finance new capital.  Instead, an investor can "draw a bill" (issue a note) on the present value of his or her existing or future marketable goods and services.  A proposed capital investment has a "present value" that can be calculated and, having value, can be turned into "money."

The investor can use the bill as money directly, paying a debt incurred with another company.  This is called "discounting," because the bill usually passes at a discount from the face value of the note at maturity.  For example, a $100,000 piece of "commercial paper" discounted with another company as a holder in due course at 2% would be valued in that transaction at $98,000.  If the holder in due course uses the bill to pay a debt of his or her own instead of holding the bill to maturity, this is called "rediscounting."  The bill can continue to circulate in this manner until the maturity date, whereupon it is presented to the issuer or "maker" for redemption at the face value of the note, $100,000.

When this process is carried out without the involvement of a bank or other financial institution, the bill is called a "merchant's acceptance."  A rough calculation suggests that in 2008 this sort of transaction accounted for approximately 60% of the money supply.  In 1839, Congressman George Tucker calculated that these "bills of exchange," as they are often called, made up more than 90% of the money supply.

The process is almost exactly the same when a financial institution is involved, although in that case it is not called a "merchant's acceptance," but a "banker's acceptance."  A commercial bank (as opposed to a "bank of deposit" such as a credit union, savings and loan, or investment bank) can transform bills of exchange (almost always in very high denominations) into smaller denomination banknotes or (more usually) demand deposits.  These days, most commercial banks are not permitted to issue banknotes, and have to purchase banknotes from a central or national bank by rediscounting qualified paper, thereby presumably ensuring an "elastic currency" that expands and contracts in tandem with the needs of the economy.

While this may seem a long diversion in a discussion on whether poverty can be eliminated, it is of critical importance.  Given that the poor do not have existing accumulations of savings that they can use either to purchase capital directly, or to use as collateral for a loan used to purchase collateral, there is only one way to alleviate widespread poverty without relying on redistribution or charity.  That is to discover some means that will allow the poor to use the same means as the rich to purchase capital.

This was the program developed by Louis O. Kelso and presented in two books co-authored with Mortimer J. Adler, "The Capitalist Manifesto" (1958), and "The New Capitalists" (1961).  The subtitle of the latter is significant: "A Proposal to Free Economic Growth from the Slavery of Savings."  Kelso and Adler did not, of course, mean that savings are not essential to the process of financing new capital formation.  Instead, they pointed out that, using advanced financial techniques such as discounting and rediscounting bills of exchange drawn on the present value of future marketable goods and services to be produced, and securing the loans with capital credit insurance and reinsurance to replace traditional collateral, people without savings (the poor) could become owners of capital without first having to cut consumption and save.  The saving would come in the future, once the capital project started generating profits and the loan could be repaid.

This is only the barest outline of a possible program for eliminating poverty.  Obviously there are a great many details to work out, but it is certainly worth investigating.

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