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Financial Instability and Underconsumption

Presented at the conference:

Production Capitalism vs. Financial Capitalism - Symbiosis and Parasitism. An Evolutionary Perspective.

A Workshop/Conference organised by Norsk Investorforum, Oslo &

SUM – Centre for Development and the Environment, University of Oslo.

September 3-4, 1998.

Arno Mong Daastøl

University of Maastricht, Department of Public Economics

P.O. Box 616, NL-6200 Maastricht MD, The Netherlands

Ph: +31.433 883636, fax: +31.433 258440

Permanent address:

Utsiktsveien 34, N-1410 Kolbotn, Norway

Ph: +47.6680 6373
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Fax: +47.66995325
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Introduction *  

Consumption and the classical school *

The financial sector and the classical school *

The barter economy system: Balance of production and consumption *

The market economy: Introduction of money *

A better taxology-typology-classification *

Two kinds of monetary heresy *

Credit basis: Labour fund or productive capacity *

Productive capacity *


A) Use of common surplus from production for the various production factors: *

B) The share of each production factors in surplus may be used for various purposes: *

C: Propensity of shares for usage *

"Dynamic Distribution"in time: Financing pensions, funds or PAYU *

The fund solution: the indirect way *

B) Investment of funds in production *

Abroad or domestically *

1) PAYU solution (pay as you use): the direct way *

"Static" Distribution: between "production factors" capital , labour and land *

Balance of incomes: "distribute or destroy" *

Balance of branches: *

Home market: *

Globalisation: *

References: *


The basic argument of this article is simple: The introduction of money as an exchange medium has not only made market transactions and resource allocations more efficient but it also brought with it a potential for disruption of the system. The reason is that money serves several roles. The task is to ensure that money should not be allowed to leave the circulation process between production and consumption and vice versa. This was the central point of many money heretics in the interwar period. It is still a point that needs to be understood better. The point also has crucial implications for funding of pensions and funds like the Kuwaiti- or Norwegian "Petrol Fund".

A relatively fitting metaphor of the problem is that of the combustion engine: In order to work it needs to be lubricated. If the engine leaks (i.e. lubricator (oil) escapes out of the system) the engine will soon stop.

The structure of the article will be as follows
  1. Short history of theory
  2. Logic of the system


This article has started off, as often is the case, as an attempt to clarify one’s own ideas concerning some matter. I will consider some basic and rather simple matters on the relation between economic stability and consumption intended to gain some perspective of the field. I will try to discuss the theme from a basic view of the matter without getting into technical terminology, of for instance Marxists and (neo-) Ricardians, that I do not master.

I will discuss the theories that Schumpeter despises more than any in the field of business cycles; those of underconsumption and of oversaving of which he says repeatedly that they are myths and can hardly be considered scientific. It is striking, however that he produces no arguments against these theories but several in favour of them and notes that Marx (his favourite in this area) held such ideas as well (Schumpeter, 1954, pp. 740ff, 1129ff)

A Norwegian economist, Brynjulf Bjørseth, published a book in 1934 that was translated and published in London in 1936. Its title describes very well the mood of the young economists during the crisis in the 1930s: Distribute or Destroy. The theme unfortunately has still relevance, as I hope to show below.

Consumption and the classical school

Much has been written about distribution, especially within the classic tradition as with Ricardo and later within the neo/Ricardian tradition by writers like Sraffa, Robinson, etc. Ricardo has often been considered the economist of distribution and not of growth. This is partly misunderstanding since Ricardo saw a proper distribution as a precondition to the growth of an economy focusing on the propensity to accumulate of the various production factors. Nevertheless he paid little attention to the other side of the game namely consumption. It was Malthus who focused on this and his predecessor Richard Jones. Both stood closer to the historical tradition in economics. However, it was Ricardo who was to make his impression upon main street academic economics in the 19th Century to the regret of Keynes who again picked up the focus of Malthus and the Mercantilists on consumption.

As in the German and English Historical Schools, Malthus, Jones, and J.S.Mill claimed that safeguarding income of the weaker (social insurance, in principle) would stabilise demand and employment apart from developing the productive forces, developing social trust and calming social unrest. Governmental law was top be the instrument to regulate property, which in the case of agrarian property was seen as undeserved by Mill.

The "classical economists" had traditionally regarded the economic system as if everybody were merchants or entrepreneurs and therefore limited their arguments to that of the production sphere, although being largely ignorant of the human capital side of it - starting from a materialist Image of Man as they did. The historical school and Ricardo, Malthus and Jones additionally focused on the decisive importance of distribution for the productive system. Jones claimed that the production form was formed by the organisation of work and thereby by distribution in the meaning of property relations (Jones, 1831). This attempt to discuss distribution was later taken up eagerly by the Distributist movement in Britain around the turn of the 20th Century, that argued against any kind of concentration of property ownership (including the State), and was associated with Guild Socialism and the Social Credit movement. (Hutchinson, 1997, p.25).This attempt to include distribution of property relations into the economic analysis separates the pragmatic view of the historists from the more ideological view of the liberalist school. As for the mercantilists, property was an instrument and nothing sacred. The historists thereby in essence claimed that a dynamic relation to distribution - property - is necessary as opposed to the more static, status quo, view of the liberalist school. Ironically a basic trait of Ricardo’s analysis, and perhaps the most valuable part, has thereby been filtered away. Mainly his deductive method (the Ricardian Vice), his addition to Smith’s trade theory (comparative advantages) and his addition to Malthus’ rent theory (marginal productivity) were allowed into the body of late 19th Century economics.

I will in the main take a look at the issue of demand and distribution from the point of the monetary cranks in the interwar era that generally may be classified as underconsumption theorists. Contrary to the production- and goods fixation of the Ricardian/Mill tradition, they believed that "money matters" or to put it differently that money is an exogenous factor in the economic system. A telling example of the classic tradition is the title of the neo-Ricardian, Piero Sraffa’s, book Production of Commodity by Means of Commodities. An early exponent of " money matters" is Gerard de Malynes (1586-1623) who claimed that an expanding money supply would not only increase the price level, but also decrease the interest rate and stimulate the economy (Malynes, 1601 & 1622). David Hume, on the other hand, claimed that,

… augmentation [in the quantity of money] has no other effect than to heighten the price of labour and commodities … In the progress toward these changes, the augmentation may have some influence, by exiting industry, but after prices are settled … it has no manner of influence. (Hume, 1752) The monetary cranks held that stimulating demand through increasing the money supply could cure slumps and unemployment. They came up with various suggestions of how to go about this, some curious and some quite ingenious. Keynes was an astute student of these ideas and modern adherents do exist: Friedman’s idea of air-bombing an economy with money (Friedman, 1969) is today repeated by Krugman’s ideas for a solution to the Japanese banking crisis. Keynes was however, a sophisticated person with many ideas that has been neglected and which we will return to. Hayek’s Free Banking idea, that he picked up from the Scottish reputed Treasurer in France, John Law (with approval from Adam Smith), argued that private banks would be more responsive to the trading needs of the markets than would a central bank monopoly. Hayek could also have consulted the British monetary cranks, of which Arthur Kitson was the pioneer - and Soddy's intellectual mentor. They attacked the money issuing monopoly of the Bank of England, that paid more attention to the value of money as against gold than to the situation in industry. Mercantilist ideas of coinage shortage was one strong originator of this idea (Heckscher,1931).

It may also be claimed, however, that private banking would increase instability.

The financial sector and the classical school

Although the financial sector had been thoroughly studied by Mercantilists like Mun, Malynes, Child, Locke, Newton, Stewart, it was forgotten with Smith and the classical school , and which Thornton criticised them for in 1802 .

Smith, Malthus, Ricardo discussed a functional distribution of surplus in order to achieve growth. In essence they took over the economic model of the Physiocrats based on barter of corn. In this model demand and supply equalled each other relatively easy. However, the classical school was more or less unable (or perhaps unwilling) to explain certain instability phenomena related to underconsumption. A reason for this was the exclusion of the financial sector and accompanied hoarding and speculative phenomena in this sector. This exclusion also goes for the neo-Ricardian school.

Ignoring a lot of work on the financial sector by Mercantilist writers, Adam Smith and the main stream of the Classical School also tended to ignore both the existence and explanation of commercial crisis such as theories of phenomena like oversaving, over-accumulation, overproduction, underconsumption, and under-spending. Say's Law is describing of this tradition in which less than full capacity utilisation was ruled out per ce, which goes for the overproduction, underconsumption, Neo-classical School as well - of the Cobb-Douglas function version.

Instability as a result of over-accumulation and accompanying inflation in the financial sector was thereby more or less ignored and the adherents have always lived their intellectual life in the periphery of academic economics - much for political reasons it is likely to assume. The flip of the coin to over-accumulation is underconsumption and therefore declining investments, growth, tax-revenue and welfare. The general glut that underconsumption implies, unemployment through deflation, is also not compatible with neo-classical analysis since it also presupposes Say's Law of full capacity utilisation. However it is understandable within this framework if

… the production function is read backwards: Q [national income] determines how much L and K are required. It is not L and K that determine Q, but sales C+ I. (Pen, 1971, p.219) As is generally acknowledged, Sismondi and Malthus paid more attention to the problem of consumption than to other economists at the time. Sismondi says concerning an entrepreneur, If it be then asked why he stops, he will answer, like the workman, that money is wanting, that money does not circulate. (Sismondi,1815, Ch.2, see also Sismondi, 1824) They are therefore also credited with being the originator of the underconsumption theory of the oversaving type. (Schumpeter, 1954, p.740) They represent, however, two distinct versions as Sismondi regards low wages as a cause of instability whereas Malthus was of the opinion that the landed aristocracy could better fill the function of efficient demand through its consumption of luxuries. This was in line with his ideas of the iron law of wages that Ricardo developed further, emphasising the danger of population growth. J.B.Clark and Rodbertus were later to follow up the track that Sismondi pointed out, although being less hostile to the danger of labour-saving machinery than Sismondi. He was probably the first to discuss the problem of an underconsumption created glut on the basis of income distribution between the two factors of production in the industrial process, capital and labour. Sismondi, Malthus and Ricardo together discussed these matters repeatedly. Also, i n German, French, "British periphery", and early American (German oriented) economic thought, there was a continuos discussion of financial phenomena.

The monetary cranks re-introduced the financial sector into British economic analysis: Douglas, Soddy, Keynes, besides German and American monetary cranks like George, Gesell, Knapp, Hayek, Mises, Friedman etc. The Scandinavians had Brochmann and Kristensen, apart from the academic economists who focused on monetary issues like Wicksell and Casell. (Douglas, Soddy, Brochmann and Kristensen are not even mentioned in Schumpeter's History…, 1954 - in spite of them playing a great role, although: hidden from most academics' attention)

The ideas of some of the cranks, rather than others, later became main stream and the link between the initiators and the successful is not hidden. Keynes, for instance, openly acknowledges his debt to Gesell (Keynes, 1936, p.353-358) - though Gesell was more of an anarchistic thinker (In the sense of Free Banking - FB) than Keynes was, with his more statist / mercantilist oriented ideas (In the sense of National Banking - NB). In this way Keynes would be closer to Douglas and to Soddy. The Norwegian Bertram Dybvad Brochmann also had hidden influence though the first Nobel laureate in economics (1969), Ragnar Frisch. Frisch borrowed, without ever stating so in public, Brochmann's ideas on national accounting, but Frisch left out Brochmann's inclusion of the household sphere and the natural resources and energy sphere. Frisch also wrote about the monetary questions and was like Keynes very open to the ideas of the heretics. (Frisch, 1933, 1933, 1934; Andvig,1980) As is generally acknowledged Frisch developed ideas similar and in parallel to Keynes.

He too emphasised that "consumer demand was the driving force of the system" and that "attempts to save could curtail consumption without giving rise to any investment". Frisch says, "One should in other words, attempt to create an indirectly planned economy." (Andvig, 1980, pp.11-12)

What Frisch writes, in 1934 could in the main also have been written today,

It should have been the function of the monetary system to make the buyers and sellers able to find each other. … But the monetary system has failed in its historic mission. Just to mention one: the monetary system to a great extent is organised as a private trade, a trade where everybody fights each other. Consider only the monstrosity that the Bank of Norway is still a limited company, evaluated by its own leaders in terms of its "liquidity" of "yield", and so on, in the same way as any private company. … we have a monetary system which does not foster the exchange activities among transactors during depressions, but on the contrary, gives effects which force the individuals to curtail theirs activities even further. … groups are forced mutually to undermine each other's position. Each is forced to curtail its demand for the goods produced and services rendered by the other groups which, in turn, will cause still further contraction of demand for tis own products, and so on. This meaningless vicious circle is what I understand by the incapsulating phenomenon. (Frisch, 1934; quoted in Andvig 1980)
In the late 1930s (with Roosevelt's New Deal etc.), WW II and the post war period the NB cranks (Keynes etc.) gained the upper hand for some time. The practice, however, most often was that of neutral central banking (CB) as opposed to more true NB with deliberate discrimination between various economic activities regarding the premises for credit. The trend in the WW II - and post WW II period was to was to move from NB via CB to FB. Therefore, starting in the late 1960s and gaining force around 1970, the FB cranks (Hayek, Friedman) have been increasingly influential, as regulation has been and is being scaled back - both on the national and the international scenes. The NB period seems to have been somewhat successful in curtailing over-accumulation and in promoting growth of production and consumption. However the problem seems to have returned with increased force in the new FB period. With FB over-accumulation in the financial sector has been increasing. The NB solution was to channel surplus into production and reproduction by controlling the capital flows. In the short run the solution was to channel the flow into demand - and in the long run into fixed capital investments. FB may be seen as an outgrowth of the classical school that did not pay attention to monetary problems. The FB school does pay attention but in reality only legitimises the old practice of non-intervention that was a result of the ignorance of the former classical school. The quarrel between the NB and FB schools was the usual dispute over "who picks the winners" question. The role of public goods was an additional question focusing on the role of large-scale investments that would need the intervention of a macro-actor (as opposed to "micro" entrepreneurs and consumers) to ensure the interests of the general public.

On the other hand, as noticed above, FB also represented a severe criticism of the deflationary austerity policy of the gold oriented central banks at the time it emerged in late 19th Century and the post WW I period. Besides, in the eyes of the critics, the NB solution paid overly attention to large-scale projects neglecting small local entrepreneurs and thereby contributed to market concentration and anti-social monopoly rents. One lesson may be that the role and effect one institution and remedy had at one time may be different today. However, also today we may observe central banks inclined to pursue austerity policies and increasing concentration on any market.

The barter economy system: Balance of production and consumption

In a barter economy production normally equals consumption. The classical school has often been accused of being a study primarily of such a barter economy. Ironically, Ricardo was a "money-changer" by birth and occupation, he used the Physiocratic notion of a farm based on barter as model for a national economy. Although Ricardo did mention money in his Principles, we cannot say that this was a central part of his theory whether in the early or late version.

An example from the classic school: Fallow or idle capital Henry Fawcett (Marshall's predecessor at Cambridge) has left us one cute example of the classical mode of thought following Say's Law of market equalisation: Products will always find consumers. Fawcett neglects the financial sector and believes in the self-equalising marvels of the perfect price mechanism and market machine. Fawcett writes in the classic belief that capital always will be reinvested in production of some sort - immediately. This contrasts as we shall see later with Hilferding's concept of fallow or idle capital. Fawcett writes, All political economists who preceded James Mill and Ricardo, and many who have succeeded them, seem to anticipate a general over-production of commodities as a possible or even probable contingency. Dr Chalmers and Mr Malthus went so far as to impress upon all, the duty of exercising a moral restraint with regard to the accumulation of capital; for if this was not done, they feared that wealth would not only be created to be wasted, and that it would be impossible to consume a great portion of the commodities produced. Sismondi was actually opposed to the use of machinery, because he believed that if the production of wealth was so much facilitated there would inevitably ensue a general over-production of all commodities. … yet it can be proved that there never has been, and never will be, overproduction in the sense that more commodities are produced than people will consume. …there would be no difficulty whatever in selling the goods if they were only offered at a sufficiently low price. …

It therefore appears that, however great may be the accumulation of capital, commodities are sure not to be produced to be wasted; there will always be persons ready to consume the commodities which are produced, if the price at which they are old is sufficiently low. Consequently the accumulation of capital, as pointed out in the last chapter, may reduce profits, but never causes a superfluous production of capital. (Fawcett, 1883, Ch.6. pp.472-476)

The market economy: Introduction of money

With the introduction of money as an intermediate potential disturbance is introduced. As often is the case when more or less perfect models are confronted with real life - their relevance vanish.

Roscher says that,

Lastly, the mere introduction of trade by money destroys as it were the use of the whole abstract theory. [Footnote: Malthus, Principles, II, ch. I, 3] So long as original barter prevailed, supply and demand met face to face. But by the intervention of money, the seller is placed in a condition to purchase only after a time, to postpone the other half of the exchange-transaction as he wishes. Hence it follows that supply does not necessarily produce a corresponding demand in the real market. And thus a general crisis may be produced, especially by a sudden diminution of the medium of circulation.' And so, many very abundant harvests, which have produced a great decline in the value of raw material, and no less so a too large fixation capital which stops before its completion,' may lead to general overproduction. In a word, production does not always carry with itself the guaranty that it shall find a proper market but only when it is developed in all directions, where it is progressive and in harmony with the whole national economy. … There will be a stagnation of the entire business, because part of its capital is paralyzed, and all the workmen will suffer damage. [Footnote: On the special pathology and therapeutics of this economic disease, compare Roscher, Die Produktionskrisen, mit besonderer Rücksicht auf die letzen Jahrzente in die Gegenwart, Brockhaus, 1849, Bd. III, 721 ff., and his Ansichten der Volkswirtschaft, 1861, 279ff.] (Roscher, 1877, Book IV, Ch. I, § CCIX) Friedrich List also points to the intimate connection of different market segments and to the damage to all from the injury to one. As opposed to Schumpeter's creative destruction, it seems like List and Roscher would argue that the main effect of crisis is hardly anything by destructive. List says, .. the success of one particular branch of industry depends on that of several other branches .. (List, 1841, p.39)

The English have thus given a striking confirmation of the opinions which we in another place have propounded and explained -- that all individual branches of industry have the closest reciprocal effect on one another; that the perfecting of one branch prepares and promotes the perfecting of all others; that no one of them can be neglected without the effects of that neglect being felt by all; that, in short, the whole manufacturing power of a nation constitutes an inseparable whole. (List, 1841, p.387)

List's comments on the most injurious effects of disruptions, especially of wars, and the need for uninterrupted production and stability add to this impression, See for instance: List, 1841, pp.294, 298 or  Chapter 24: The Manufacturing Power and the Principle of Stability and Continuity of Work. List says that, On manufactures, however, the least and briefest interruption has a crippling effect; a longer one is fatal. The more art and talent that any branch of manufacture requires, the larger the amounts of capital which are needful to carry it on, the more completely this capital is sunk in the special branch of industry in which it has been invested, so much the more detrimental will be the interruption.

By it machinery and tools are reduced to the value of old iron and fire-wood, the buildings become ruins, the workmen and skilled artificers emigrate to other lands or seek subsistence in agricultural employment. Thus in a short time a complex combination of productive powers and of property becomes lost, which had been created only by the exertions and endeavours of several generations.

Just as by the establishment and continuance of industry one branch of trade originates, draws after it, supports and causes to flourish many others, so is the ruin of one branch of industry always the forerunner of the ruin of several others, and finally of the chief foundations of the manufacturing power of the nation.

The conviction of the great effects produced by the steady continuation of industry and of the irretrievable injuries caused by its interruption, and not the clamour and egotistical demands of manufacturers and traders for special privileges, has led to the idea of protective duties for native industry. (List, 1841, p.298)

A better taxology-typology-classification Definition is analysis, and nothing is more important in economics today than analysis. (Commons,John. (1893). Fairfield NJ: Kelley, 1963, p. 21) We will return later to a discussion of saving but let us first look at consumption vs. investment.

The leading historian and theoretician of economics Germany in the middle of the 19th Century was Wilhelm Roscher. His Principles… Book IV is devoted to consumption (Roscher, 1877, Book IV). Sections CCXI and CCXII are devoted to the two types of consumption: Productive and unproductive. Roscher says that this classification originally is Plato's (The Republic, VIII, p. 559). Keynes later refers to this typology (Keynes, 1930, II, Ch. 28, Sec. ii, p. 126)

For several reasons, this classification is more enlightening than the classification consumption and investment. First it makes more obvious that the difference is only a matter of degree, and secondly it makes more obvious that certain actions classified as investment today has little to do with consumption, namely financial investments. The latter difference, that of productive consumption vs. financial investments is today categorised as being more or less the same, "investments". By removing this veiling mode of classification, we may reveal some new or rather old and forgotten insights. As noted by Roscher, financial investments are a kind of sterile storage until channelled, and if, into consumption of kinds. This is a potential disturber of the peaceful balance and equilibrium - in the perfect model of the classical school. The money heretics later pointed out that this disturbance was due to the different roles of money; as exchange medium; as value measurer; and as wealth storage medium.

Roscher asserts that,

There is no production possible without consumption. …

There are different degrees of productiveness in consumption also. … (Roscher,

1877, § CCXI)

One of Roscher's chapters has the telling heading Necessity of the Proper Simultaneous Development of Production and Consumption (Roscher, 1877, Book IV, Ch. I, § CCXV). After a discussion of the two areas he writes,

Hence, one of the most essential of a prosperous national economy is that the development of consumption should keep equal pace with that of production, and supply with demand. In footnote 8 he declares that, The necessity of an equilibrium between production and consumption was pretty clear to many of the older political economists. Thus, for instance, Petty … Temple … North … Becher … Boiguillebert … Berkeley … Hume … Forbonnais … Quesnay … Letrosne … Mirabeau … Verri … Büsch…

The moderns have frequently inequitably neglected the doctrine of consumption. Thus it appears to be a very characteristic fact that in Adam Smith's great book, there is no division bearing the title "consumption" and in the Basel edition of 1801, that word does not occur in the index. Droz says that in reading the works of certain of his followers, one might think that products were not made for the sake of man but for their own sake. But on the other hadn there came a strong reactio with Lauderdale … Sismondi … Ganilh … but especially, and with important scientific discoverie, Malthus …St. Chamans … And so according to Carey, Principles, ch.35, § 6, the real difficulty does not lie in production but in finding a purchaser for the products. But he overlooks the fact here that only the posessor of other products can appear as a purchaser. From another side, most socialists think almost exclusively of the wants of men, and scarcely consider it worth their while to pay any attention to the means of satisfying them. (Roscher, 1877, § CCXV)

As against the classics, H.Carey points to the potential disturbing causes to consumption when claiming about cotton production that, Overproduction cannot exist, but underconsumption may and does exist. The more that is produced, the more there is to be consumed; and as every man is a consumer in the exact ratio of his production, the more he can produce the better it will be for him and his neighbour, unless there is some disturbing cause, preventing the various persons desiring to consume from producing what is needed to enable them to effect their exchanges with the planter, to the extent that is necessary to their comfort. (Carey, 1851, p.103). In opposition to the ignorance of the classical school not only of the financial sector but also of its independence, Rudolf Hilferding's Finance Capital is the classic discussion of how capital came to liberate itself from production, after having been tied to it since merchant capitalism and simple accumulation ("buy cheap sell dear") dominated the markets. Chapter 4 has the telling title The periodic tendency of capital to liberate itself and lie fallow (Hilferding, 1910 pp.151-167) where he discusses the reason why capital is pulled out of productive circulation, a process which he calls "the liberation of money capital". On commercial crisis Roscher has the following to say,

The growth of a nation's economy depends on this: that production should always be, so to speak, one step in advance of production, … Now, the politico-economic disease which is produced by the lagging behind of consumption, and by the supply being much in advance of the demand, is called a commercial (market) crisis. (Roscher, 1877, § CCXV)

Most theorists deny the possibility of a general glut, although many practitioners stubbornly maintain it. J.B.Say … J.S.Mill …(Roscher, 1877, § CCXVI)

All these allegations are undoubtedly true, in so far as the whole world is considered one great economic system, and the aggregate of all goods, including the medium of circulation, is borne in mind. The consolation which might otherwise lie herein is made indeed to some extent unrealizable by these conditions. It must not be forgotten in practice that men are actuated by other motives than that of consuming as much as possible. … There are, everywhere, certain consumption-customs corresponding with the distribution of the national income. Every great and sudden change in the latter is therefore wont to produce a great glut of the market. [ Footnote: If all the rich were suddenly to become misers ... a multitude of former consumers, having no employment, would be obliged to discontinue their demand. Over-production would be greater yet if a great and general improvement in the industrial arts or in the art of agriculture has gone before. Compare, Lauderdale,Inquiry, 88. …] (Roscher, 1877, § CCXVII)

The latter point of general improvement in the industrial arts is reminiscent of today's so-called paradigm shift in the IT sector.

Two kinds of monetary heresy

After depressions, there have been two kinds of heresies: Money demand- and money supply heretics.

The monetary heretics claimed that money suffered from serving several (potentially mutually exclusive) purposes at the same time. The attainment of these purposes often mutually excluded each other. Money serves the purposes of exchange, wealth measurement and wealth storage. The latter purpose may undermine the former.

After the depression of 1815; The Birmingham School of Thomas Atwood (Atwood, 1791) was allied to the Chartist movement. After WW I, there were many heretics, for instance Foster, Catchings, Douglas, who saw underconsumption (over-saving) as the cause of depression and monetary expansion as a remedy. Douglas came up with several suggestions, one was a general basic minimum citizen salary. Krugman's suggestion to helicopter money over Tokyo goes even further.

The orthodox objection to the claims of the money supply heretics has always been that expansion of money leads to inflation. We will get back to this below concerning Soddy's similar ideas.

Gesell may be claimed to be a money demand heretic, as may Steiner (Steiner, 1921) and Brochmann (Brochmann, 1922, 1923, 1956). A central idea with these heretics is the claims that money held would have to be reduced in value over time - a kind of inflation - though instruments like stamped money. This would spur spending and circulation.

Credit basis: Labour fund or productive capacity

Investments must be financed with claims to production. This is the essence of credit, i.e. goodwill or trust - in future re-payment. Investments are productive consumption and has their corollary in an abstention from unproductive consumption. Soddy's point is that these loans - for productive consumption - can never be repaid but will live in the shadow-land of the economy as interest bearing debt (possibly provoking higher taxes if the debt is public) until cancelled.

Traditional main street economists in the Mercantile (monetary) tradition of Adam Smith would claim that investments have to be financed with saving in advance, or to with another expression, financed by the Labour Fund i.e. surplus that has not been consumed. Soddy agrees that saving has to precede investment.

I have been surprised several times that Frederick Soddy, who dedicated his Wealth…to the modern father of British monetary heretics, Arthur Kitson, so often hold view very similar to orthodoxy. This is clearly true in this case as well. Soddy writes,

If the issue of money precedes abstinence … This raises prices and tends after a short while to reduce employment and production even below the original level, … (Soddy, 1933, p.299) What the orthodox, including Soddy, are missing here is that this is only correct if the orthodox precondition of full capacity utilisation is fulfilled. If it not, there is clearly room for money expansion without inflation. This was a main point with Kitson who forcefully attacked the abstinence theory that Soddy holds so dear. (Kitson, 1894) But even so there is the possibility of improving that capacity to produce with injections of credit: If productivity is raised this will cause prices to fall, i.e. deflation as opposed to the claimed inflation. Hutchinson writes,

Arthur Kitson concluded that 'credit should be based on the productive capacity of the whole of society' (Kitson, 1894). To this end, the medium of exchange should be free from government control or the control of powerful individuals.

Kitson developed the second theme of underconsumptionism by attacking the theory that trade and industry must necessarily be financed from savings, i.e. from abstinence and the surplus of the idle rich. Consumption, and not abstinence, was the means to stimulate production and create wealth. (Hutchinson, 1997, p.27)

The Norwegian heretic Bertram Dybvad Brochmann held very parallel ideas although writing in a more religiously moulded fashion attacking the modern worship of Mammon. His ideas changed somewhat over the years, and in 1956 he wrote an essay called Real Economy Contra Fictive Economy. Saving in the Time of Abundance. Why Norway goes bust. (Brochmann, 1956) For instance he writes,

General saving leads today to mutual sabotage. … Conclusion: … Personal saving of money in the form so far practised, should in the future not be stimulated, since this, as shown above, restrains the circulation of money and leads to less turnover and lower activity in general. … People should in contrast be induced to buy useful and durable things. This form of saving should be stimulated instead of the old method of general saving of money. This is not alone a necessary rearrangement, but an absolutely necessary rearrangement if we are to be able to receive the technical goods of today and tomorrow, and is this not what Men want? Development hardly lets itself be set back.

I would like to emphasise a point that is central to all the heretics described, this is their open hearted and devoted technology optimism, their belief in the limitless potential of Man. Their followers today, however, seem to have been able to interpret this the way around, somehow.

Productive capacity

However, saved income – from whatever source, for instance interests in order to make the point more obvious - does not guarantee that there will be productive capacity to account for increased demand as a result of using funds for investments.

List said about the Adam Smith’s theory on saving that,

He reduces the process of the formation of capital in the nation to the operation of a private rentier, whose income is determined by the value of his material capital, and who can only increase his income by savings which he again turns into capital.

He does not consider that this theory of savings, which in the merchant's office is quite correct, if followed by a whole nation must lead to poverty, barbarism, powerlessness, and decay of national progress. Where everyone saves and economises as much as he possibly can, no motive can exist for production. Where everyone merely takes thought for the accumulation of values of exchange, the mental power required for production vanishes. A nation consisting of such insane misers would give up the defence of the nation from fear of the expenses of war, and would only learn the truth after all its property had been sacrificed to foreign extortion, that the wealth of nations is to be attained in a manner different to that of the private rentier.

The private rentier himself, as the father of a family, must follow a totally different theory to the shopkeeper theory of the material values of exchange which is here set up. He must at least expend on the education of his heirs as much value of exchange as will enable them to administer the property which is some day to fall to their lot.

The building up of the material national capital takes place in quite another manner than by mere saving as in the case of the rentier, namely, in the same manner as the building up of the productive powers, chiefly by means of the reciprocal action between the mental and material national capital, and between the agricultural, manufacturing, and commercial capital.

The augmentation of the national material capital is dependent on the augmentation of the national mental capital, and vice versâ.

The formation of the material agricultural capital is dependent on the formation of the material manufacturing capital, and vice versâ.

The material commercial capital acts everywhere as an intermediary, helping and compensating between both. (List, 1841, p.(227-)228)

In the section called When Saving is Injurious Roscher says that, The act of saving, if the consumption omitted was a productive one, is detrimental to the common good; because a real want of the national economy remains unsatisfied. Douglas and later Keynes, on the other hand, claim that new credit for investments (productive consumption) does not have to come from saved income alone, but must rather be issued on the basis of the societal free and unused capacity to produce. This is not a matter of saving (abstinence from unproductive consumption) preceding productive consumption (investment) and therefore producing before financing. It is on the other hand a matter of financing before producing and thereby issuing credit before the productive ability is installed: (Bjørseth, 1934, p. 150; Keynes, 1930, II, p. 220). This is the case when we have unused capacity, i.e. an non-neo/classical situation. It is also the case if investments are highly productive consumption.

Credit can be created and expanded until this capacity has been used fully without danger of inflation. Channelling credit into expansion of this capacity to produce means that both this capacity and credit over time can be expanded without any limit, in principle seen in isolation from for instance limits of resources such as space.

Schumpeter has similar ideas about the basic role of capital, being the catalyst of socio-economic transformation into a more efficient structure,

Capital is nothing but the lever by which the entrepreneur subjects to his control the concrete goods which he needs, nothing but a means of diverting the factors of production to new uses, or of dictating a new direction to production. This is the only function of capital, and by it the place of capital in the economic organism is completely characterized. (Schumpeter's own italics. Schumpeter, 1934 (1961), p.116, in chapter III: 'Credit and Capital. The Nature and Functions of Credit.') Keynes clearly acknowledged the importance of improving capacity to produce that List called the productive power and claimed as the true wealth of a country as opposed to its monetary riches. It is a common mistake to believe that Keynes only was interested in short run problems as if he thought financial policy could not affect long term growth. However, although Keynes argues that authorities must keep up demand in the short run ("In the long run we are all dead."), he also argues explicitly that authorities must use financial policy to create investments being the most important source of growth in the long term. "Productive consumption" must be furthered, especially through "large scale" public investments financed by "cheap and abundant credit". Keynes says, Loan expenditure must spread its beneficent influence around the world.(Keynes,

1933, kap.3, pp.20-22, see also Keynes, 1926, Ch. IV, and Keynes, 1930, II, Chs.28, 29, 37).

The practical problem concerning issuing credit will be to measure the exact prevalent productive capacity and issue credit correspondingly. This can never be anything but a process of intelligent guessing. Post WW II measurement if GDP is an attempt at handling this point.

But the problem is most likely not practical but political and as Robert W. Zimmerer wrote in an email,

Since the U.S. Government can print money and does so to underwrite the public-private financial system of the U.S. why does it have a debt? Why does it not just print the money outright which it needs to build public infrastructure, the military, NASA, etc.? Because it is not culturally acceptable. To fund public "investments" the U.S. Treasury sells bonds (securities) to private buyers. The Federal Reserve Bank then can buy them back with legal tender printed by the U.S. Treasury!

(pg 420) In this way the U.S. Treasury incurs debt on which it pays interest to the security holders and fees to the brokers which "place" them. This is very profitable business for the financial community. Many hands are greased by this circuitous route.

  1. Use of common surplus from production for the various production factors:
  1. W - Wages
  2. P - Profits
  3. G - Landed/ground/real estate rent + financial gains - as a third by-product of the productive process
A W, P, and G have different characteristics and therefore different inclinations of employment but may all be channelled into one or the other purpose of the following activities:

B) The share of each production factors in surplus may be used for various purposes:

-The delineation between 1 on the first hand, and on the second hand 2 and 3 is fluid and often a matter of definition.

  1. Cp - (Re-) productive consumption – reinvestment in production, infrastructure
  2. Cu - Unproductive consumption – luxuries, defence
  3. F – Financial/Real estate investments - in financial activity (FIRE)
1 is fruitful usage of resources whereas 2 and 3 are sterile, relatively speaking of course. This is reflected below in their effect on the price levels.

Cp may lead to further surplus and reiteration of the processes A and B, and is in

principle deflationary. In the goods markets because it may lead to higher productivity, and in the financial markets if it leads to higher supply of financial assets. Cu ends the process but is in principle inflationary- in the goods markets because it leads to higher demand but not higher production. The effect on the financial market is dubious: F may lead to surplus without material support, and is in principle inflationaryin both the goods market and in the financial market:

If channelled into the goods market the result will be a higher monetary basis without the material support and therefore inflation. If channelled into the financial market the result will be inflation in financial assets since there will be no higher on the financial markets

C: Propensity of shares for usage

(A crucial chapter that needs to be expanded by empirical and theoretical studies)

An analysis of the how and why different factors' (share-receivers) will use their income (their propensity) for various usage is crucial in order to stake out a policy with which to influence this apportionment.

W is prone to be invested in productive consumption (Cp) in the sense of

reproduction of the labour force in both its quantitative and qualitative aspects, with financial reinvestments (Fr) as the second best alternative. As to how much is used for the second category, unproductive consumption or luxuries, is a matter of definition. However, for lack of knowledge among the working population about productive consumption (Cp) regarding companies, reinvestment into companies is not a likely choice. This may, however, be changed by education. Some demand from wages may spill over to unproductive consumption (Cu). However, the border between productive consumption (Cp) and unproductive consumption (Cu) is fluid. This is even more so as a country becomes more mature and more investment is needed to reinvest into reproduction of a labour force of high quality. For instance, knowledge of ancient Italian art also by study trips may be said to be necessary for an art designer and not a luxury. Thereby with time, seemingly or formerly unproductive consumption (Cu) may turn out to become productive (Cp). In the case of labour, the surplus may be eaten as Malthus claimed, or it may be invested in the workshop or in the general financial markets with effects more like the funds.

Investing W into Fr would be pro-cyclical according to for instance Friedman's permanent-income hypothesis (Friedman, 1957): When financial markets fall in value so does the monetary wealth of the labourer and according to the theory - and experience it seems - so does expenditure. Public social security works the way around, as we shall see.

P is prone to be invested in productive consumption (Cp) but will consider both unproductive consumption (Cu) and Financial investments (Fi) as doable alternatives depending on the pending situation. Capital's share of the surplus is less likely to be all eaten – consumed since as already Adam Smith argued there are limits to the capacities for consumption of wealthy people (speaking of the stomachs of land estate holders). In case legal arrangements do not favour reinvestment into production, surplus may be more likely to be invested in financial assets. F is prone to be invested in any of the three depending on the pending situation. For lack of proximity to the productive process, productive consumption (Cp) is not a favoured choice. Centralisation and largess is likely to increase this tendency. Therefore both unproductive consumption (Cu) and financial investments (F) are favoured choices of gains from land/real estate and financial gains. If consumption (Cp and Cu) is small initially or becomes small, there is less opportunity to continue leading surplus back to this sector. Surplus will therefore go to financial investments (F). Since

"Dynamic Distribution"in time: Financing pensions, funds or PAYU

(pay as you use)

As the industrial world turns grey, we get more older and less younger people to feed them. One question concerns how to finance this? A second question concerns the effects for the stability of the financial and economic system.

Social security creates confidence with the individual consumer and strengthens demand. A lack of this creates savings, especially in an insecure situation, as a downturn in an economy, which is the situation when this is more lethal than in any other situation. A lack of social security therefore works pro-cyclical and makes an economy more volatile. The social security system is important in this regard as we may observe today in Japan, both for its contribution to in/stability and for its mammoth size in developed countries like Japan. In Japan alone, they have a size many times the collective debt of the developing countries.

The fund solution: the indirect way

We are not going to look at funds as a short-term buffer but as a more long-term strategy. The buffer strategy refers to relative short-term use of funds as an equalising device that may work between fairly similar nations.

The funds must be invested somewhere.

Let us now look upon the ICs as if they constituted one nation and the LDCs and NICs as they constituted another nation.

There are four options: In financial markets or in production, abroad or domestically

Financial investments:

Concerning financial markets the importance of the emerging markets area is so small, relatively speaking that this need not be considered. This may seem strange considered the recent turmoil, but compared with the markets in the ICs this still is true I believe. Accordingly financial investment must be domestic in the developed markets. The efforts to invest in the emerging markets in the mid-1990s did not fare well for several reasons that will not be a theme here for reasons of space.

If credit is channelled to the financial part of the developed markets they will lead to a situation where large funds after some time may dominate the national economies. These funds are normally general in nature i.e. the funds are not connected to any particular type of industry. These people know little about real production and are not likely to invest relatively less in this area. Instead, this implies that investment will tend to go to general investments like financial assets of any sort. When the supply of assets are relatively limited and demand goes up this generally leads to inflation in the financial markets: bouncing stock, bond and currency markets.

This would mean that we get further into financial capitalism where the tail wags the dog ¼ : i.e. financial capitalism. Production decreases for lack of funding and demand whereas financial markets boom as in a pyramid game: The first in win if they get out before the pyramid collapse. The game is manly mental (psychological) and concerns trust or belief in the direction of the market. As soon as trust changes, the market changes.

So, driving the financial markets are not the gains from profits but rather the stream of new money into the pyramid supported by faith that the pyramid will grow - for a while. But pyramids do go bust.

P ß

=> F Ý => Crash ?

As a web-friend, Robert W. Zimmerer, wrote commenting upon the theories of Fredrick Mishkin (Mishkin ,1995),

When banks are confident that real estate values are going up they loan "against" the expected value of the land. Of course this requires borrowers who are confident they can resell to another borrower at a higher price. When the land "collateral" for the loan has no willing buyer at a higher price, the owner wishing to sell and his bank face problems. This situation arises over and over again. Today banks in Japan hold loans against real estate which is decreasing in monetary


B) Investment of funds in production

Less likely since administrators are distant to these activities, but this is obviously a task of politics, education and law-making - to channel funds into purposes that serve general welfare. See the articles by Gordon L. Clark on this matter. (Clark, 1998 etc.)

Abroad or domestically

It is normally argued, for instance in Norway, that the nation cannot supply itself in the future and must therefore build up funds from which it may live in the future. Thereby creating demands upon foreign populations – in real effects parallel to that happens when a nations borrow from abroad (the legal situation being different concerning opposed demands for the future). This policy cannot be pursued if all do the same: as if all borrow: Someone has to produce.

If the industrial countries (ICs) all live off their funds, then other groups of nations , i.e. less developed countries (LDCs) and newly industrialised countries (NICs) must be able produce and to pay back part of a surplus to the ICs and also be able to live off the capital that we borrow them today. This will produce an indebted situation in the LDCs which only will be a problem if the credit is not used for productive consumption and instead goes to unproductive consumption or financial hoarding - as has been the case so far - largely.

Therefore it is crucial that the fund are channelled to the NICs and LDCs. Further it is crucial that the LDCs and NICs invest in ways that are productive making it possible to produce a future surplus that may be paid back to the lenders (the ICs). It will furthermore be crucial to establish good public and private bureaucracies in order to channel this credit productively. So far this has not worked well and prospects are dim

1) PAYU solution (pay as you use): the direct way

The alternative to sending surplus to NICs or into financial markets will channel credit into production and in particular into productivity increasing investments. Productivity increases makes it possible in the ICs for less youngsters to support more "grey" people.

This is made more possible by the following fact: Creating (pension) funds means that the surplus, savings must be taken from wages, in particular, but also in some national systems also from the employer’s accounts. The alternative is that surplus is channelled directly back to production without going through the middleman that the funds constitute. This can be done in several ways: By siphoning surplus directly from the company’s accounts back to production through investments. However, as will be pointed out above, wages must receive its share to ensure demand for the produced goods and thereby make it worthwhile to invest in production. The alternative is excessive consumption of luxuries by the establishment. But apart from the moral issue this will be less productive since productivity demands high quality labour force that demands a wide distribution of surplus.

Although some saving might be encouraged from wages this should not be too much simply because there has to be some demand. The more saving from wages, the higher wages must be over a necessary "fixed" minimum of demand for goods. The savings from wages could be siphoned back to production, for instance though stock investments, leading to a democratisation of capital based on ownership – as opposed to a "elitisation" (opposite of democratisation) of capital when capital receive relatively more than labour. However, as noted elsewhere, this democratisation will be pro-cyclical.

In both instances, when labour or capital receive "more" than the other factor, surplus may be siphoned back to production or not. Public regulation may create arrangements that ensure that surplus is channelled back to production in the general interest. If this is not ensured, we have several possibilities as noticed above concerning the propensities of the production factors shares to be used for various purposes.

Additionally this strategy may not make a future claim on the LDCs and the NICs.

But will the LDCs and NICs receive less productive investments with this strategy?

"Static" Distribution: between "production factors" capital , labour and land

This section is, as you can see not finished, but I gather you will grasp the logic.

Balance of incomes: "distribute or destroy"

If: More income to profit & no channelling of profit in general interest

& limited ability of upper class to consume:

=> less demand for goods and production

=> little incentive to invest in production

=> more incentive to invest in finance

=> inflation in financial assets and P/E down

=> volatility

=> crash ): social contract necessary with reasonable wages or (less good) high luxury spending from P and Fr stable income / wages through indexing, social security will promote stability of


Balance of branches:

If: more branches in ones own country

=> the less reason to trade

& => the less middlemen & less dependence upon foreign demand

=> more stability

On the latter point, List wrote,

The whole social state of a nation will be chiefly determined by the principle of the variety and division of occupations and the cooperation of its productive powers. (* 1841, p.159),
List warned against the destabilising effects of a lack of industry, It is dangerous to allow the prosperity of a country's arable land to be entirely dependent upon the export of cereals and raw materials in exchange for manufactured products. Such agricultural exports are liable to serious fluctuations. (* 1837 a, p.56) To this he added the danger and vulnerability of one-sided economies in particular those lacking an industrial sector and therefore dependent upon foreign consumption for its own economic stability. A monocultural primitive economy was more prone to indebtedness and commercial crisis than a mature and heterogeneous economy. (List, 1841, pp.147, 280ff, concerning the need for uninterrupted production and stability; see List, 1841, pp.294, 298)

Home market:

create demand by protection of production, infrastructure

=> more control over demand – important in times of crisis

& => less costs of transport

& => less middle men and exchange meaning less reason for

speculation Globalisation: moves demand to groups with less purchasing power

=> less global demand

& creates less public revenue in industrialised societies => less research and innovation (in ind.countries and therefore globally) Carey writes, The nearer the consumer and the producer can be brought to each other, the more perfect will be the adjustment of production and consumption, the more steady will be the currency, and the higher will be the value of land and labour. The object of protection is to accomplish all these objects, by bringing the loom and the anvil to take their natural places by the side of the plough and the harrow, thus making a market on the land for the products of the land. (Carey, 1851, p. 190) Carey studied these "disturbing causes" further, in his Financial crisis: their causes and effects (Carey, 1864), he claims that throughout US history, prosperity has accompanied protection and crisis and paralysis has accompanied free trade. He writes, The nearer the consumer to the producer the more instant and the more regular the exchanges of service, …if we should avoid those crises … if we would have the regularity of the societary movement - and if we should promote the growth of freedom - we must adopt the measures needed for bringing together the producers and consumers of food and wool, and thus augmenting their power to have commerce among themselves. The essential characteristic of barbarism is found in instability and irregularity of social action. … you will most assuredly be led to the conclusion, that the stability whose absence you deplore, is to be sought by means of measures looking to the close approximation of the producer and the consumer and to the extension of domestic commerce. … All experience, abroad and at home, tends, thus, to prove that men become more free as the domestic commerce becomes more regular, and less and less free as it becomes more fitful and disturbed. Such being the case, the questions as to the causes of crises, and as to how they might be avoided, assume a new importance … (Carey, 1864, Letter First) Carey finds these causes to lie in speculation that is made possible in periods with free trade since these periods are also accompanied with a buyer's market in the labour market. (Carey, 1864, Letter Second)

Keynes points to impossible and possible solutions to depressions,

Currency depreciation and tariffs were weapons which this country had in hand until recently as a means of self-protection. A moment came when we were compelled to use them, and they have served us well. But competitive currency depreciations and competitive tariffs, and more artificial means of improving an individual country's foreign balance such as exchange restrictions, import prohibitions, and quotas, help no one and injure each, if they are applied all round.

We are left, therefore, with the broad conclusion that there is no effective means of raising world prices except by increasing loan-expenditure throughout the world. It was, indeed, the collapse of expenditure financed out of loans advanced by the United States, for use both at home and abroad, which was the chief agency in starting the slump. (Keynes, 1933, p. 19)

Leif Johansen has a similar point,

One of the main arguments for free trade is that the individual countries shall be safeguarded against arbitrary encroachments of their export. I think experience shows that this is no real safeguard. Additionally, there is a danger hanging over every country that the system suddenly may collapse.

I would claim that some of the arguments for free trade as a safeguard against encroachments on a country's export are built upon an illusion or upon wrongful thinking. …

In a larger scheme of things: Is it obvious that it is an advantage that countries are forced into a race in the direction of contractive policy, or at least put a brake on a possible expansionary policy, in order to secure the balance of trade, rather than securing the balance in the foreign economy through direct measures and are free to lead an expansive domestic policy that lead to better utilisation of labour and other resources? (Johansen, 1976, p. 18)

On the problem of international capital movement, Keynes wrote, "I sympathize with those who would minimize, rather than with those who would maximize, economic entanglement among nations. Ideas, knowledge, science, hospitality, travel – these are the things which should of their nature be international. But let goods be homespun whenever it is reasonably and conveniently possible and, above all, let finance be primarily national." (Keynes, John Maynard. (1933). "National Self-Sufficiency." Yale Review, 22: 4 (June): pp. 755-769; reprinted in D. Moggeridge, ed., The Collected Works of J. M. Keynes, Vol. 21, 1971, London: Macmillan) Keynes further noticed that, "Freedom of capital movements...assumes that it is right and desirable to have an equalization of interest rates in all parts of the world. It assumes, that is to say that if the rate of interest that promotes full-employment in Great Britain is lower than the appropriate rate in Australia, there is no reason why this should not be allowed to lead to a situation in which the whole of British savings are invested in Australia, subject only to different estimations of risk, until the equilibrium rate in Australia

has been brought down to the British rate. In my view the whole management of the domestic economy depends upon being free to have the appropriate interest rate without reference to the rates prevailing in the rest of the world. Capital controls is a corollary to this." (Keynes, Collected Works, Vol. 25, 1971, p. 149)


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