III. Recent Criticisms of “The New Economics”

IN ITS ESSENTIALS the so-called “new economics” is almost as old as the use of money. Again and again it has been used to justify government extravagance and to defend schemes for debasing the coinage or inflating the currency. It was the theory John Law persuaded the government of France to let him try out in the early 18th Century. The result was the Mississippi Bubble, the best-known boom and bust of recorded history up to 1929. In the 19th Century, Lauderdale, Malthus, Sismondi, and J. A. Hobson advanced much the same views, not to mention Karl Marx and his disciples. Keynes did little if anything more than use new terms for old ideas.

“Keynesianism is a sin of my youth”

A well-known, present-day economist, however, Dr. L. A. Hahn, claims the doubtful honor of having refurbished and reissued what he now regards as this fool’s gold of economic theories. In a book of essays entitled The Economics of Illusion, Dr. Hahn confesses that “Keynesianism is a sin of my youth,” which he committed several years before Keynes got credit for it.³⁸

As a young economist and banker in Germany in 1920, Hahn ardently espoused the idea that easy credit policies are necessary to keep a modern economy fully stimulated and working at top speed. Without this stimulus, he believed, it would get clogged with unused purchasing power, or savings. The result would be unemployment and idle factories. A few years later, as he saw the results of these easy-money policies, he came to regard inflation as a worse evil than deflation. Therefore, he re-examined his theories and concluded he had been mostly wrong in his original explanation for depressions.

The causes of business depression he now finds, not in oversaving, but in a necessary readjustment after a preceding credit inflation. In addition, he says, depressions may be aggravated and prolonged by policies which prevent reduction of costs after the excesses of the boom are liquidated. These policies are mainly: (1) wage rigidities protected by unions and wage-hour laws; (2) burdensome taxes on enterprise; and (3) government restrictions on trade and production, such as tariffs, crop controls, exchange restrictions, and price controls.

Keynesism as “The Economics of Illusion”

At first, says Hahn, currency-and-credit inflation speeds up spending and increases employment. This is because certain costs (e.g., wage rates, rents, and interest charges) lag behind selling prices of the products. This stimulating effect, however, lasts only until the lagging costs catch up to the rise in prices—as they soon do. After that, further inflation only raises the general price level and reduces confidence in the currency. Eventually it must result in a flight of capital, which in turn sets off a degenerative spiral of growing unemployment, currency inflation, rising prices, and further export of capital.

Therefore, Hahn says, the Keynesian theory that currency inflation and increased spending can increase employment is valid only if one assumes a lag in wages, and this lag will continue only as long as wage earners can be kept in ignorance of what is going on.

For it [the Keynesian view] presupposes an economy whose members do not see through the changes brought about by monetary or fiscal manipulation — or as some might say, the swindle. Above all, it presupposes that people are blinded by the idea that the value of money is stable — by the “money illusion.”. . .³⁹

Hence he calls Keynesism, “the economics of illusion.”

Inflation encourages uneconomic policy

Most people will agree with Hahn that a policy which depends on such an illusion has little chance of success today in a nation of free discussion and collective bargaining. In fact, union wage demands now generally run ahead of any increase in over-all spending, at least in the United States.

Some Keynesians recognize this, at least as a possibility. Samuelson, for example, says that the possibility that wages and prices may begin to soar as spending increases, even though there is still unemployment and excess capacity, is “America’s greatest problem and challenge.” “If businessmen and trade-unions react perversely to an increased demand, fiscal policy cannot be relied upon to achieve and maintain full employment.”⁴⁰ The alternatives he offers, if “business, labor and agriculture” do not learn to curb their demands, are: (1) a reserve army of 10 million jobless; (2) continued inflation; or (3) government price and wage controls which “would involve a degree of planning incompatible with past, and probably present, philosophical beliefs of the great majority of the American people.”

Yet, one looks in vain in this leading textbook for suggestions that “business, labor and agriculture” may restore free markets, at least in domestic trade, or that it would help if they did. “Laissez faire is dead! Long live compensatory and fiscal policy!”

It is here that Hahn takes issue with the Keynesian view. He argues that: (1) there cannot be chronic underinvestment in free markets; and (2) the remedy for chronic unemployment is the return to a free labor market and removal of trade barriers. When government uses an easy-money policy to cure unemployment caused by too-high wage rates or monopolistic price-maintenance, he says, it encourages the unioneers and monopolists to continue their uneconomic policies. Thus it perpetuates and aggravates the very evils that are the root of the trouble. Eventually, these forces get out of control and the result is the catastrophe of a runaway inflation.

Hahn concedes the case for a “managed currency”

In The Economics of Illusion, Hahn pursues the Keynesians in the twists and turns of their dialectics to ferret out some of their inconsistencies and fallacies. At times his pursuit is successful, and he is one of the best-known critics of Keynesian doctrines, a sincere advocate of private enterprise.

In the course of his argument, however, like many other critics of government intervention, Dr. Hahn gives away his own cause against “compensatory fiscal and monetary policy.” He recommends that government use deficit spending to stimulate business in the recovery phase of the business cycle, and he condemns the “hyper-classicism of those who opposed attempts at reflation” in the early 1930s.⁴¹

What Hahn objects to, therefore, is not a compensatory fiscal and monetary policy, but bad timing in applying it and neglect of other devices, such as abolishing restrictions on free markets. He writes:

In order to restore confidence in the price structure, the government is justified in compensating, and even obliged to compensate, the lacking private demand by proper expenditures for which it acquires the means by loans not by taxes.⁴²

But who is to decide when the producers have completed the necessary adjustments and thus merited a helping hand from government? If government recognizes that the time for recovery has arrived, why don’t investors? Does government get a sudden access of wisdom in the trough of a depression?

And how is the government to borrow the money for its compensatory spending?

Here Hahn accepts the Keynesian view that the gold standard must be repudiated. He agrees with the Keynesians that the central-bank authorities should fix discount rates and determine lending policies according to their estimates of domestic credit needs rather than according to the need for protecting gold reserves against a possible “flight of capital” to foreign countries.

In place of the gold standard, Hahn favors a “money-free” economy, in which bank deposits are as good as cash (legal tender), and there is always plenty of legal-tender money to take care of all possible bank runs. Then individuals’ desire for liquidity, he says, cannot cause deflation because the government can supply the banks with enough paper money so that they need never refuse loans or liquidate investments in order to get cash to pay off their depositors. This, he says, will make Keynes’s “liquidity-preference” concept an anachronism.⁴³

One might add that it would also open the door for what Hahn himself considers unsound credit policy. For example, it was this self-same “money-free” policy which caused the inflationary boom of the 1920s. Under government urging and government orders, the central banks of almost all countries fostered an era of easy money (credit) in order to finance public works and deficits in government industries, to prop up various forms of economic disequilibrium which arose out of World War I, to maintain prices and wage rates for over-expanded industries, and to maintain confidence despite the unbalance and the unsound use of credit.

This story—the record of government’s role in the boom-and-bust of 1920-1932 has so far been told best by the late Benjamin M. Anderson, in his Economics and the Public Welfare, published just after his death in 1949. In this eye-witness account of the period, 1913-1946, Dr. Anderson shows the futility of Hahn’s hope that government control of currency and credit can lead to a “sound” credit policy or increased financial stability.

“When government plays God”

Dr. Anderson originally titled his book “When Government Plays God.” His friends vetoed this title on the ground that it might hurt the sales of the book in academic circles where it is usually necessary to appear disinterested. Doubtless his friends were right, but Dr. Anderson, I think, believed that it was not a virtue to be disinterested about the results of government currency management, which apostles of “the new economics” advocate.

At any rate, “When Government Plays God” describes the theme of the book.⁴⁴ Seldom have facts been so marshalled to show the progress of a plausible fallacy in wreaking havoc with the economic life, not merely of one nation, but of every nation. That fallacy is the easy-money, deficit-spending theory of the New Deal and of the Keynesian economists: the theory that government may promote prosperity by taking steps to increase the quantity of currency, bank credit, and unproductive spending.

The New Deal before Franklin Roosevelt

Dr. Anderson dates the first phase of the New Deal in the United States from 1924, the year in which a Federal Administration of this country dictated an easy-money policy (“an immense artificial manipulation of the money market”). According to the author’s own account, however, he might have dated it from 1917, for as he shows, the United States Government used this banking system, its own creature, to help finance the inflation of World War I and the postwar boom of 1919-20.⁴⁵ True, the Federal Reserve Banks regained some independence of action in 1920, but their tardy and moderate increases in rediscount rates in that year were blamed for the depression which followed, and thereafter they were never again free from political direction and interference.

Dr. Anderson tells vividly and in detail how this political domination of bank policies brought about the runaway stock market boom of the late 1920s. Then he goes on to show how the subsequent crash and depression were intensified and prolonged by “frantic governmental economic planning” which began even while the stock market crash was going on. For the most part his account is as clear and readable as a newspaper account of a bank holdup.

“It was dishonor”

And a bank holdup is what the United States Government staged in 1933 when it seized depositors’ gold and gave the President authority to issue inconvertible paper money and reduce the gold value of the dollar. After quoting Senator Carter Glass concerning the immorality and fraud of these acts, Dr. Anderson says:

To the grand old Senator, morality was something written in the Heavens, eternal and unchangeable. But the pragmatic philosopher . . . was no less shocked than the Senator. There is no need in human life so great as that men should trust one another and should trust their government, should believe in promises, and should keep promises that future promises may be believed in and in order that confident cooperation may be possible. Good faith — personal, national, and international — is the first prerequisite of decent living, of the steady going on of industry, of government financial strength, and of international peace.

The President’s course in connection with the gold standard and in connection with the Thomas Amendment, represented an act of absolute bad faith. . . . The Government was bound by its solemn promises, and the President was personally bound by his campaign utterances and by the platform of his party. It was dishonor.⁴⁶

Thus the moral indignation of an economist who saw that trust and good faith are the foundations of all human cooperation broke forth in bitter condemnation of those who sought to promote prosperity by deceit and spoliation.

Yet indignation must be governed by understanding. It is Anderson’s detailed and expert examination of the financial record that gives his Economics and the Public Welfare its authoritative weight and penetration as a critique of Keynesian proposals for an inconvertible currency and deficit spending.

Government control must be “political”

In this clear and detailed moving picture, however, one may find something of which even its producer was scarcely aware. As Anderson describes the inflation of 1924-29, he attributes it solely to the “weakness and bad judgment” of certain Federal officials in yielding to political influences. He suggests that “stronger” men would have done better.

But was it mere accident that the control over the Federal Reserve System was in the hands of “weak” men? Will any administration long tolerate government officials (e.g., members of the Federal Reserve Board) who show good financial judgment instead of good political judgment?

Many persons, like Senator Glass and Dr. Anderson, who strongly favor private enterprise in banking as a general rule, make an exception in favor of government “control” of central bank policy. They see the many advantages of close cooperation among individual banks. One obvious way of getting this cooperation is for government to set up a banker’s bank, like the Bank of England or the Bank of France (both of which used to be privately owned). But, when government sets up such a bank and gives it a monopoly of certain functions, it creates a special privilege and a corresponding political obligation. Therefore, most advocates of a central-bank monopoly propose that this bank must be “regulated” by government as a public utility.

The founders of the Federal Reserve System in 1913 were warned of the danger of political control of such banks, but they hoped to prevent political “abuses” by such devices as that of permitting the private bank members to elect most of the directors of the 12 Federal Reserve Banks, and by giving long-term appointments to the members of the Federal Reserve Board. Most classical economists, even among those most devoted to free enterprise, still cling to the belief that somehow the monetary system can be managed by such a government-appointed board which, “like the Supreme Court,” is free from political influence.

Careful reading of Dr. Anderson’s book should shake that belief, especially if one keeps in mind also the outcome of the Reconstruction Finance Corporation to which Anderson seems to have given approval. As Economics and the Public Welfare makes clear, the Federal Reserve officials have usually been among the ablest and most honest persons that could be found. They did not act politically because they were weak; they were not disloyal to their trust. Instead, they were faithful to the political trust of those who appointed them.

This is not to say that all central banking must be political in nature or policy. But such central banks as government sets up and controls must serve political purposes. Failure to recognize this fact, or to make it clear, is the one serious flaw in Anderson’s otherwise penetrating analysis.

Excessive bank credit in the 1920s

What Anderson did see and make clear, as few economists do, is the fallacy of the Keynesian “purchasing power theory.” This is the theory that lack of spending is the cause of large-scale unemployment and depression, and that government should intervene to assure enough money and spending to maintain at all times the demand for labor and goods.

Anderson counters this theory with the fact that bank credit was more than sufficient in the 1920s due to the very sort of government intervention that the Keynesians recommend. This over-abundance of bank credit caused investment to run ahead of savings, and gave rise to a disastrous boom and bust.

Next he goes on to show how the processes of production and trade themselves generate a sufficient quantity of credit whenever free markets are given a chance to develop the equilibrium necessary for a good quality of credit.

Credit in free markets: an incomplete exchange

In free markets, credit arises when one person transfers to another his services and goods, or valid claims on services and goods, in return for a promise to pay later. A seller advances credit when he lets a buyer take and use goods before paying for them. A wage earner gives credit to his employer when he works for a week or two before pay day.

Credit is not, therefore, a matter of bank checks, banknotes, or figures on a bank’s books. These are merely records of credit transactions, not credit itself. Credit is an incomplete exchange of goods.

When government does not control banking, except to enforce contracts, well-managed banks serve only as credit brokers, not as credit manufacturers. They record credit transactions and act as clearing houses and agents for credit developed and used by individuals and business firms. They keep books for the real manufacturers of credit, who are the producers and exchangers of goods and services.

Credit develops with trade

Producers and dealers may create and use credit with little or no resort to banks. In certain sections of the United States in the first half of the 19th Century, banks were often hard to reach. Some states actually prohibited private banks by law. In those places, business developed with comparatively little bank credit, and even with comparatively little money. Merchants bought the products of farmers and artisans, giving in return purchase-orders good at their shops. In that case, the producers sold the goods on credit to the merchant. The credit was liquidated when these producers used their purchase-orders to buy other goods from the merchant. If the merchant owned a stock of goods to begin with, he could sell on credit to producers, and they could discharge their debts later by selling their goods to him in return for their own I.O.U.s.

In such a society, the volume of credit obviously depended on the amount of goods produced and exchanged. This amount, in turn, depended on the efficiency of producers and merchants—their ambition, inventiveness, ability to cooperate, richness of soil—and on one other thing: trust.

Banks register credits

Trust came as a sequel to competence and honesty. Competence and honesty developed as suppression of violence and enforcement of contracts created a favorable political environment for production and trade.

When these conditions are present—honor, trust, and a fund or flow of goods — there is credit. The supply of credit rises and falls with the amount of exchangeable goods produced, and this amount depends on the efficiency of producers and dealers. It does not matter whether the goods are commodities or services, durable or perishable, consumers’ goods or producers’ goods (tools and machinery), the quantity of credit in free markets depends on its quality as measured by its command over goods. This quality in turn, depends on the faithfulness with which producers and traders meet one another’s expectations in production, trade, and finance.

Producers do not need the banker, therefore, to create credit. He is useful in keeping records and as an agent for producers and traders in ascertaining the credit-worthiness of individuals in particular transactions—when the owners of goods and credit want such service. As his customers gain confidence in his work, they let the banker record more of their credit transactions and let him act as their agent in lending funds that would otherwise be idle. Then the idea may arise that the bank creates the credit.

What “inflation” means

If producers sell goods on credit to persons who do not keep their promises to pay for them (perhaps because their plans go awry), there is trouble. The goods are gone and trust is destroyed. Then credit shrinks and people complain of a shortage of credit. At this point, if government has suppressed the gold standard, it may issue more paper money or set up means for using government bonds as a basis for deposit currency. Then it may give or lend this money or currency to otherwise insolvent debtors. In other words, it may monetize debt. This permits creditors and debtors to continue making the bad loans and unproductive investments which caused the losses.

This is the essential meaning and evil of “inflation.” It is an expansion of currency for unproductive spending and “investment.” One result of it is a decline in the purchasing power of money, that is, a rise in prices. Another result is that those who receive the government’s handouts get goods without giving goods or services in exchange. This is what a counterfeiter does.

Of course, individuals are bound to make mistakes in use of credit. They may produce the wrong goods or give credit to dishonest or incompetent persons. In free markets, however, such mistakes carry their own penalty and remedy. Imprudent lenders lose their power to lend, and spendthrift debtors lose their power to borrow. Credit management, therefore, gravitates into the hands of those who learn to use it productively.

The gold standard prevented inflation

Yet, although credit in free markets arises mainly out of production, producers do not ordinarily measure it in terms of bushels of wheat or tons of coal. They state it in terms of the monetary unit in which they price their goods—so many dollars, francs, or pesos. In modern times, when free to choose, they make silver or gold their standard. They state their prices in terms of such standard money, and they prefer to be paid in it or in claims that are readily exchangeable for it. In international trade, gold is the standard, even when governments forbid it in domestic trade, at least between sovereign nations. (The United States has largely destroyed the monetary usefulness of silver by its manipulations of the silver market on behalf of the silver producers.)

Under the gold standard, the banker has another function in addition to that of recording credit transactions and serving as agent in clearing, transferring, and advancing credits. He acts also as a merchant in gold, or a keeper of a warehouse for gold.

Soon after governments (e.g., those of the United States and England in the 19th Century) began to enforce the contracts which bankers and producers made in terms of standard money, the bankers’ purchase orders (banknotes and checks) replaced almost all others. “Trading stamps,” streetcar tokens, “coupons good only at our store,” and occasional “due bills” payable in service or merchandise were instances of purchase orders not convertible into gold at a fixed ratio; but people used these forms of purchase orders for only a small part of the total trade in most countries prior to 1933. When producers were free to choose their own currency, they used mainly one that was readily convertible into standard money at stable, predetermined rates.

When goods were as good as gold

As the gold standard developed, gold became the measure for credit and a means for controlling credit expansion. This was because buyers of goods used it to measure the value of the goods which gave rise to credit. Every producer had to price his goods low enough in terms of the standard money so that buyers would take these goods in preference to the standard commodity, gold. As long as producers used their credit to produce goods that were more desirable than gold, at the prices asked for them, their credit was “good.” It was as good as gold.

Under these conditions, banks and other lenders could safely expand credit only as the supplies of gold increased, or as producers found ways of producing goods that, at the prices asked, buyers preferred to gold. When they expanded credit faster than this, both borrowers and lenders suffered losses. This means that inflation of currency or credit could not proceed far, under the gold standard, before automatic checks came into play.

Under the gold standard, even government borrowing was deflationary, not inflationary. There were two reasons for this. First, it reduced the supply of loan funds available for private borrowers and brought about a rise in rates of interest. Second, it caused growing distrust of all credit. This was because government pays its debts out of taxes, which reduce the ability of taxpayers to pay their private debts. Creditors knew this. Therefore, as government debts mounted, they grew more cautious. Eventually they began to convert their bank credits into gold, which they hoarded or shipped out of the country for safe keeping.

This potential demand for gold acted as a brake on the expansion of credit, both government credit and private credit.

It is because of this check-rein effect on currency and prices that Keynesian economists want governments to “abandon” the gold standard. This means that they urge that government prohibit citizens from using gold as money, prohibit the issue of banknotes convertible into gold for domestic use, and prohibit (or refuse to enforce) contracts in terms of gold. In other words, their proposal to “abandon” the gold standard is actually a proposal to suppress it.

Gold prevented inflation, not expansion, of credit

Advocates of a “managed currency” contend that gold prevents or impedes expansion of credit. The output of gold, they say may not keep pace with the output of other commodities. If the currency is tied to gold, a lag in gold production must cause a shortage of money and declining prices for other goods. This decline in the general level of prices, they argue, tends to depress industry and employment. Consequently, a shortage of gold is likely to retard economic progress, if a nation remains on the gold standard and tries to maintain a fixed monetary value for gold. It is because of this depressing influence of the gold standard in the past, they claim, that governments so often abandoned it or revalued (“debased”) their currencies.

This line of argument, however, ignores several facts:

1 Gold is one of the most widely distributed of all natural resources. It is found in all parts of the globe; and, throughout the centuries, man seems to have found ways of increasing the output of gold about as fast as the output of other goods. There is no evidence that this correlation between the production of gold and the production of other things may not continue indefinitely.

2 Inventions to economize gold usually keep pace with other forms of invention. In freedom, improvements in banking techniques permit increased use of credit. This makes it possible to carry on more trade with a given amount of gold.

3 Gold is used chiefly as a measuring stick, not as a means of exchange, as long as credit is used productively. Under the gold standard, it is no more necessary to transfer gold with every transaction than to buy a new ruler for every measurement. When gold does change hands it is usually to settle balances or to make up deficits. In free markets, as enterprise increases the quantity of trade, it also increases efficiency in trade, so that deficits and unpaid balances decline relatively to the total volume of business.

4 Sharp declines in the price levels under the gold standard are not due to sudden shortages of gold, but to misuse of credit and subsequent repudiation of debts, or to government restrictions on trade and exchange. These conditions cause contraction of credit or prevent use of credit in purchase of goods. For example, the tariff war of 1930-1932, which began with the Hawley-Smoot Tariff Act of the United States in 1930, reduced the saleability and exchange value of goods throughout the world.

5 The surest way to make people want more gold is to prohibit them from having it, or threatening to do so. Inconvertible currency drives gold into hiding or raises its value because it destroys confidence in all other forms of currency.

6 A period of declining prices for staple commodities is likely to be a period of most rapid progress in levels of living for wage earners if the decline arises from increased efficiency in production.

Credit currency may be preferred

For most transactions, credit currency (banknotes or bank checks) is more convenient than gold, and most persons prefer it to gold as long as they believe that it is based on sound investments. Aside from uses in the arts, a person wants gold mainly when he begins to lose confidence in credit, that is, when he fears that the custodians of credit are advancing too much of it for unproductive purposes, so that their gold reserves may be insufficient to meet their possible losses.

In other words, the gold standard restrains credit inflation: no other means of control is so effective for this purpose. At the same time, use of gold in free markets does not prevent expansion of credit sufficient to permit full employment of the economy’s productive resources. Under the gold standard, the limits of credit expansion are set by productive capacity, not by the size of the gold reserves.

In free markets, goods generate credit

Prudent persons accumulate reserves of valuable goods, or claims on goods, including reserves of gold and claims on gold. Such reserves improve their credit rating and increase the quantity of credit which they may get or give.

Similarly, where a great many citizens prudently accumulate wealth and build productive capacity, there we find an abundance of credit and buying power as long as the citizens are free to trade with one another and with people of other nations. It is not the great stock of gold which makes the United States the world’s greatest reservoir of credit today, but our people’s vast output and stocks of exchangeable goods (including gold), which they earn and produce or which persons of other countries entrust to them for safe-keeping.

The basic fallacy of Keynesian theory

This brings us to what is perhaps the basic fallacy of Keynesian thought. The Keynesian economist treats of goods and credit as though they were two quite separate things. He teaches that the output of goods creates a need for credit and currency. He warns that goods may go unsold, forcing down prices and causing unemployment, unless government: (1) adds to the supply of currency as the output of goods increases, and (2) sees to it that those who get the new money spend it promptly.

The classical view, on the other hand, is that goods themselves are the source of all sound credit and sound currency. Let us see what this means.

Goods give value to goods

In free markets, every producer may extend credit to the full value of the goods he offers for sale. That is, he may sell all of these goods on credit if he finds customers who can someday supply something he wants in exchange, or who can supply something (goods or claims on goods) which he can trade for what he wants.

In other words, the credit which a producer can give depends on the amount of goods he can get for them in future. This means that the amount of credit available is always potentially equal to the output of goods. It becomes actually equal to output as buyers and sellers agree on prices and enter into contracts.

One problem of maintaining employment and output, therefore, is that of removing obstacles to the making of agreements on the terms of trade, that is, on prices of commodities and services.

Credit vs. credit instruments

Many persons fail to understand the relation between goods and credit because they think of credit only in terms of the paper instruments of credit, especially the instruments of bank credit, such as banknotes and bank checks. Of course, when the output of goods and the volume of trade decline, the flow of credit instruments also declines. From this fact it is easy to conclude that the way to increase trade is to increase the supply and rate of circulation of banknotes and bank deposits.

The fallacy of this conclusion should be clear from the evils which ensue when governments try to apply it in practice. But let us consider further the relation between credit and credit instruments.

Credit instruments are the records of credit transactions. They include commercial credit instruments, such as promissory notes, due bills, trade acceptances, I.O.U.s and other evidences of debts.

These paper forms are not credit, but evidences of credit that producers are granting. The real credit consists in the value of goods which sellers give up in return for the buyers’ promises to pay later.

Of course, a seller may use a customer’s I.O.U. to pay a debt which he himself owes. A private, commercial credit instrument then circulates as currency.

More often, he takes the private credit instrument to a bank which uses it as a basis for granting bank credit (banknotes and bank deposits). He does this because bank credit instruments circulate more easily than commercial instruments.

The bank’s business, then, is to substitute its better-known name for the names of nonbanking debtors on the credit instruments used in trade. It accepts commercial instruments at a discount (to pay for its service), and grants bank credit against them. That is, it issues banknotes and permits the drawing of checks to take the place of the commercial credit instruments which it holds as security. Banknotes and bank checks, therefore, are credit instruments, like the nonbank instruments which they replace, except that they are more readily accepted in trade.

Goods pay for goods

Those who buy goods on credit, of course, are debtors. They usually pay their debts with checks on bank deposits and with banknotes which they get by selling goods and services to bank depositors and note holders. In other words, they pay their debts with currency which the banks put into circulation on the basis of the debtors’ own original promises-to-pay.

When debtors use credit productively, they create new values which their creditors will pay for. In buying such values, the creditors give the debtors the wherewithal to pay their debts.

The original producers who bring goods to market and sell them on credit, therefore, in effect loan the goods to buyers. These buyers add to the value of the goods, and sell enough of them back to the creditors to settle their debts.

The original buyers keep for themselves any goods left over after paying their debts. They may consume these goods as income or use them to extend credit to other producers. The more productively they use the credit they get, therefore, the more they profit. Thus the productive use of credit increases both goods and credit.

Is saving dangerous?

The Keynesian economist, however, warns that the original sellers may not use all of their credits to buy the new goods as they come to market. He fears they may try to save too much of their credits, for one reason or another. In that case, he says, some debtors may not get enough funds to pay what they owe for goods bought on credit from those who are now holding back their buying power.

One answer to this argument is the fact, shown by Professor Lutz’s study of corporate income and outgo (see pages 66-67), that business firms actually spend and invest money about as fast as they get it. In other words, they invest as fast as they save. Apparently they save only in order to invest.

The same is true of much, if not most, saving by individuals. It is saving for specific investment purposes. Some of this saving goes to investment agencies, such as insurance companies and banks. Some of it the owners invest directly in productive equipment or service.

But can banks and other agencies find investment outlets for all possible savings? What is to prevent such savings from running ahead of investments? And, if for some reason savings momentarily exceed investment, will this not reduce total spending and cause the dire results predicted by the Keynesian economists? Will not sales and prices fall, profits decline, and unemployment rise?

Savings increase demand for labor

The answer to these questions is to be found in the nature of the investment demand for funds.

Investment means spending for productive purposes. It means hiring labor and buying materials to produce more goods. The extent of demand for investment funds, therefore, depends on the amount which use of these funds can add to the output of goods. If anyone wants more goods and is able and willing to help produce them, there is a corresponding use and demand for investment funds to hire and equip him for that purpose. The demand for such funds is equal to the desire and ability to earn and consume.

Obviously, if everyone has all of the goods he wants, there will be no demand for more funds to invest in expanding output. Or, if everyone has as much work as he wants to do or can do, there will be no demand for additional investment funds.

Lack of investment demand, therefore, may mean that everyone is fully employed; or it may mean that no one is able and willing to work for the wages he can produce and earn. In either case, no investment can further expand production.

Increased savings, however, would not alter these conditions for the worse. Instead, these savings would have effects precisely opposite to those which the Keynesian economists predict. The pressure of increasing savings seeking investment tends to reduce interest rates. Investors must be satisfied with lower rates of return. This reduces the cost of capital and thus increases the share of the product which employers can offer to wage earners. Therefore, wages rise and the demand for labor increases. Labor that was formerly too inefficient or too high-priced to be employed now becomes employable. Employers can now pay wages sufficient to induce reluctant workers to take jobs.

Inventions increase profits and wages

Inventors and engineers, who increase producers’ efficiency, increase rewards for users of capital, both employers and wage earners. The enterprise of every worker looking for a job or trying to do a job better also creates opportunity for investment, because it offers more opportunity to use capital goods and reward investors. Immigration and other means of increasing the labor force increase investment opportunities and demand for savings.

But, although inventions, discoveries, enterprise, and immigration increase the demand for savings, it does not follow that an increase in savings is harmful when these conditions (which Samuelson and other Keynesians call “dynamic factors”) are absent.

On the contrary, the increase in savings brings about a division of the product more favorable to wage earners. It increases the demand for labor and the opportunities for employment.

When lower profits mean higher wages

If the increased willingness to save brings down the rates of return on investments, it is because savers are willing to save more than before at former rates or to save as much as before at lower rates. Consequently, the fall in rate of return does not cause them to save less than before or to withdraw their savings. It merely checks the increase and helps bring the rate of saving into equilibrium with the investment demand for funds.

And, even if the increase in savings continues despite the decline in return from investment, the worst that could happen would be that employment opportunities and wages would continue to rise, a result that surely should not be cause for alarm.

Therefore, as long as producers (including wage earners) want work and are willing to share the net output of industry with those who put up the capital, there is a return on investments and a demand for savings. If there is no investment at that rate of return it must be because people prefer to spend their money on consumption goods rather than to save it. In that case, the lack of investment is due to a lack of thrift and savings, not to an oversupply of savings as Keynes contended.

It is the business of entrepreneurs, banks, insurance companies and other investment agencies to ferret out investment opportunities, endorse credits, issue the memoranda we call banknotes or keep the records we call deposit currency, and thus put savings to work.

If there are both idle savings and idle workers, it can only be because of non-economic barriers to production and trade. These barriers may be tariffs, union picket lines, taxes, subsidies to idlers, or government interference with prices and wage rates.

Such restrictions prevent entrepreneurs from arranging terms of exchange and carrying on trade. In others words, the markets are not wholly free.

Inflation robs producers and destroys credit

According to this classical view represented by Anderson, the practical remedy for such a shortage or stagnation of credit is not for government to print money or force an increase in deposit currency, as Keynes proposed. Such a policy does not remove the causes of the stagnation or credit shortage. Instead, it enables those to whom the government gives the new currency to get goods without giving goods in exchange—as a countefeiter does. It robs producers, and it tends to perpetuate the barriers and interferences which are the real cause of the difficulty.

The economic remedy for a shortage of credit is to take away the barriers to the production and exchange of goods, so that producers may create earned credit and earned credit currency. This policy assures an ample supply of credit and currency. More important, it is the only way for producers to get the goods they want in exchange for their own.

Currency inflation dilutes credit and redistributes it. It finances unproductive expenditures, such as over-expansion of certain industries as compared with others, war costs, private or government extravagance, or purchase of “surpluses” to maintain prices. It creates “debt for dead horses.” It encourages unwise speculation, and unproductive investment. It discourages saving. It creates disequilibrium between prices and costs, between the output of capital goods and consumers’ goods, and between debts and ability to pay.

The longer such inflation continues, the greater are the vested interests in the uneconomic activities which the new currency finances. These uneconomic activities cause waste of productive capacity. They reduce capital or retard its increase.

All of this increases business uncertainty. Investors know that eventually such credit must be liquidated by burdensome taxes, by cancellation of debts, or by further debasement and revaluation of the currency — or perhaps by a combination of all three. Furthermore, the longer such liquidation is postponed, the greater is the difficulty of making the necessary readjustments when the inflation ends.

Government policies caused inflation, 1913-29

During World War I, as Anderson shows, nearly every government resorted to currency inflation. This, and the war itself, gave rise to serious economic unbalance throughout the world—as inflation and war always do.

After the war and during the 1920s, governments tried to stave off the depressing effects of this unbalance. They sought to maintain prices and wage rates by policies restricting competition: tariffs, cartels, and unionism. With the help of the Federal Reserve banks of the United States, they continued their deficit financing to support markets by government loans, subsidies, doles, and relief works.

These attempts to maintain unbalanced conditions by restricting trade and expanding the quantity of bank credit caused still greater unbalance and further deterioration in the quality of credit.

Eventually, the destruction of confidence and credit and the exhaustion of reserves brought about repudiation of obligations and a downward spiral of deflation and depression.

It was not a surplus of savings, therefore, a lack of investment, or an excess of output that brought to an end the boom of the 1920s, Anderson contends but a shortage of new savings and depletion of liquid reserves, due to losses on unsound loans and investments.

Corporations save in order to invest

A statistical study by Professor F. A. Lutz, Corporate Cash Balances, 1914-43, bears out Anderson’s contention that hoarding of funds was not a cause of the 1929 crash. As far as Lutz’s figures show, corporations spend their money about as fast as they get it, and 1928-29 was no exception. Contrary to the assertions of Keynesian economists, these figures indicate that business savings are very closely related to investments.

Corporate “surpluses” are not mainly cash. They are not hoarded, or surplus funds. They are the value of all that the corporation owns, including buildings and machinery, after deducting the amount of liabilities and a certain rather arbitrary figure to represent the stockholders’ investment. Business saves to invest, not because it wants to hoard cash or because it does not know what to do with the money; and it spends the money it invests as quickly as any other money it pays out.

“We planned it that way”

One other point Anderson makes clear. The depression of 1930-39 was no ordinary one. It was not merely a “natural reaction,” or “period of correction,” resulting from previous excesses. It was characterized by more government “planning,” throughout the world, than any other in the past 150 years.

This “planning” was supposed to stop the depression and bring back prosperity. It consisted partly of new restrictions on trade to maintain or raise prices. These restraints at once reduced the credit and buying power of producers. Governments also continued deficit spending, which wasted much-needed savings, reduced confidence in currencies and credit, and caused a paralyzing flight of capital from nations with more “planning” to those with less.

In Anderson’s view, which he supports with a wealth of factual data, it was these “positive” and “constructive” policies of government which led to the speculative excesses of the 1920s. Further development of the same policies during the subsequent depression prevented the readjustments necessary for recovery. He writes:

Prior to 1924 we had not regarded it as a Federal Government function to make employment. Employment was a matter for the people themselves to work out. Beginning with the Federal Reserve purchases of Government securities in 1924, we have had Government policy directed increasingly toward making employment. The explanation of the good figure for employment prior to 1924, and of the desperately bad figures for employment which followed 1929, is to be found in precisely this fact. Under an old-fashioned Federal Government, which, in financial matters, was concerned primarily with its own solvency and with the protection of the sound gold dollar, the people themselves solved the problem of employment amazingly well. When the Federal Government took over and undertook to solve the problem for them, grave disasters followed.

President Roosevelt inherited a terrific volume of unemployment. He did not cure it. The figures for 1933 are worse than the figures for 1932. . . . In only two years of the Democratic New Deal period prior to the outbreak of World War II did the annual average figure for unemployment get below 8,000,000. And in the best of these two years, namely 1937, the figure stood at 6,372,000, which is 12 per cent of the labor force, as compared with 11.2 per cent of the labor force in the year of extreme depression, 1921.

The historical record is damning. The New Deal, viewed as an economic policy designed to promote employment, is condemned by the historical and statistical record.

. . . . The degree of unemployment does not tell the full story. The amount of slack in the industrial situation . . . is also a matter of unused capital and unused technological knowledge. The New Deal policy, as we have seen, had made capital timid in the extreme and had greatly retarded the application of new technology.

---

We came into the period of the second World War with a heavy obsolescence, a large body of unused technological ideas, and a great deal of idle capital,, and, as shown by the foregoing table, with 9,080,000 men unemployed, on the average, in the year 1939.

---

In 1939 we had idle men, idle money, and idle technological ideas on an appalling scale. The war set them to work, but it took the war to do it.⁴⁷

The growing appetite for inflation

The war which put men and machines to work, however, has left the nation with a huge legacy of debt, a crushing tax burden, a depreciated currency, a great dearth of equity (venture) capital, an insatiable appetite for easy money, and an apparatus for inflation that seems irresistible.

Like the war, the current armaments program is giving us “full employment,” although less in proportion to the working force than private enterprise usually offered in the much freer markets before 1930, 1924, or 1914. But government spending for armaments, like the spending for war and for prewar relief works, is further distorting economic relationships, adding to debts, liquidating the thrifty, creating new appetites for inflationary borrowing and spending, and depleting the nation’s resources.

If we saw any nation but our own following this course, would we be optimistic for its future? We know what such policies have done to other nations. Can our own country escape a similar fate?

The Keynesian economists urge adoption of a “managed currency” and various forms of government intervention in the economic life of their fellow citizens. Their idea is that government should supply an economic wisdom that private enterprise lacks or is unable to use. But even these economists see the uneconomic results of the government intervention which they advocate.

Are these uneconomic results merely unfortunate accidents? Or is there something in the nature of government that must always bring such results from the attempt of governments to manage the economic affairs of the citizens? Can government ever supply private enterprise with an economic wisdom which it would otherwise lack?