The biggest hoax in Economics: How CPI maintenance promotes inequality (Part III)
In this third article to this series on inequality, we will see how, by targeting the CPI that ignores productivity-induced price deflation, savings are surreptitiously taken from consumers and handed over to capital owners, mirroring what we saw in the first two articles where the excess money created relative to demand ends up in the hands of Capital in the form of excess profits. Consumers pay more than needed to incentivize Capital, which benefits by a higher level of profits that is equal to the additional money created by the Central Bank banking system. This article delves deeper into the ‘how’ and why this is potentially a greater problem than simply having to deal with the question of the power over the distribution of the unnecessary spoils between Capital and Labour. I.e., why left wing policies also inevitably fail at maintaining a balance of power, causing policy inevitably to veer to the right time and again.
To briefly recap from the second article, we saw that money is created whenever the bank makes a new loan. By simply borrowing $100 from the bank, you get to pay for your purchases and the seller gets to deposit the $100 into his bank account. And voilà, an additional $100 is created. Economists are generally un-phased by this, as they will argue that both loans and deposits have increased by $100, so what’s the big deal? On net you still have zero and nothing more seems to have been created. The question, as we saw in that first article, is whether that additional $100 is willingly held as new additional bank balances, as in our example of everyone wanting to hold $12 instead of $10. Or whether people want to maintain $10 and therefore spend away that extra $2 until it is finally absorbed into higher prices as the circular flow finds its new pace. Of course this will mean that people will be forced to hold $12 at the end of the day anyway, as that’s the amount of money in the economy, and you will need $12 as float to pay for the same goods you could have bought with $10 previously.
What we really want to see is the money supply expanding and contracting as people increase and decrease their demand for money balances, as only in that way will the circular flow remain unaffected from monetary effects. Economists refer to such a state as one of a ‘neutrality’ of money, where changes in its supply or demand have no effect on prices. Money should ideally be ‘neutral’ so that the real economy remains unaffected by changes arising from the side of money.
As an aside, most Economists seem not to be aware of the above requirement as a condition for money neutrality. Instead they squabble over whether the money supply should be completely fixed (as in 100% backed by gold) or not, missing the whole point of relativity that hangs on the continuously changing subjective preferences for money balances. They evade this because they have no means of actually measuring this. And what they cannot measure, they cannot see.
Given that we have never really been able to achieve a neutral money under a Central Banking system, most Economists no longer believe that money can be neutral. This is largely based on the observance of the empirical evidence. Any debate over the question is no longer one of how money can be made neutral, which it is obviously not, but one over the empirical evidence of whether it is ever neutral. Do you see the problem? If we hold up so high the god of empirical evidence, we remain forever blinded under its shadow, carrying on as ever before, which only reinforces our view that that is simply the way the World works! For as long as we fail to imagine an alternative world, where the empirical outcomes could be entirely different to the ones actually being observed today, we remain forever stuck in the present one.
Enough philosophizing now, let’s get back down to theoretical matters by thickening the plot with some simple Keynesian analysis.
The Savings Investment dichotomy
The core problem of the Keynesian has always been: how to ensure that Investment equals Savings for should Savings exceed Investment, we have a depression.
Central Bankers are also driven by this fear, because such higher savings implies a psychology of hoarding and therefore a lack of spending. Hence they try their best to make sure investment is always higher than savings as there are no detrimental effects to this; in fact the effects are exactly the opposite. It leads to market exuberance. Unfortunately they fail to realize that there is a law of karma working against them: overdo it in one lifetime of a Central Banker and you risk underdoing it in the next phase of the Business Cycle. The only way to escape from the effects of this karmic law is to somehow get the investment savings equilibrium just right. But in order to do that you have to know where the correct center of gravity lies. Central Bankers believe it to lie in stable consumer prices (or mildly rising ones, which only makes matters worse).
The typical Keynesian Identity in its most rudimentary form states that Y = C + I, in other words income is the sum of consumption plus investment and that Y = C + S, i.e., income must be the sum of consumption and savings, as clearly we either spend or save out of our income. The left hand side of the equation is disposable income and the right is expenditure. Thus the argument goes, if Y of the first equation is equal to Y of the second and C = C, it follows that S must be equal to I. But is it?
There are two ways of looking at these equations: (1) as representing different time periods or (2) as representing the same time period. The former is more intuitive, although not really considered by Keynes. So for example, Y = C + I clearly determines income: you calculate Y by adding consumption and investment expenditures together thereby determining income in the hands of the sellers for any specific time interval. Y = C + S tells us how we dispose of income earned. Clearly you will first have had to have earned that income in order to dispose over it. In this sense S need not equal I, nor need C = C because they refer to different time periods.
The second way of looking at it is to force both equations into the same time frame. In that case, S is tautologically equal to I. This simply follows because you know you are speaking of the same Y and C, therefore S must equal I.
We will show that despite this being true: that S is equal to I within any time frame, Y and C can nonetheless still fall in subsequent periods. This will be seen to be due to a tension within S between what people want to save and what they are forced to save in order to consummate the investments made by capital owners under the direction of the Central Bank interest rate policy.
Traditional economic theory teaches that you cannot have investment without savings. It is easy to imagine having savings without investment by simply not investing those savings. However, you cannot get around S being equal to I in real terms, as an unplanned build up of unsold inventories or spare capacity will manifest to make up for the holding back of spending, putting a dampener on production (unplanned inventory changes are part of I).
In the old days, when the monetary system was more constrained by the gold exchange standard, one often had to save up enough money or obtain the necessary funding from willing co-investor savers before one could invest it into producing new machines, for example. Nowadays, you simply go to the bank, who gives you the loan to start your investment. Does that mean S does not have to equal I? Had the banks only intermediated their existing customer savings deposits to provide the investment loans, it is easy to see that S would equal I. But as they simply created new loans, thereby creating entirely new deposits, is it still true that S is equal to I? And if it is true, where is the S coming from to meet that additional I, that has effectively been created out of the bank manager’s discretion?
I is investment into say the manufacture of new machines. The company obtains the loan from the bank to employ the workers to produce those machines. This is where the new money goes into the hands of the workers who are the consumers that get to spend that new money on consumption goods first. Bearing in mind that the new machines are not yet ready to produce more output, so these additional consumers get to bid away at the available output, driving up their prices.
The new deposits created from that investment loan have thus passed through the accounts of the worker consumers into the accounts of the companies. How does the circular flow continue? How do we get the money, particularly the new money used for the initiation of new investments, that is now sitting on company balance sheets, to flow back into the hands of the consumers? After all, companies need that money as depreciation reserve for the eventual replacement of those assets once they are worn out. And the more they invest to employ workers, the more they subsequently have to hold back for only much later capital replacement.
Before answering that question, let’s step back again to see how S is still equal to I. When that company took out that loan to build Capital, it effectively has both savings and investment in its double-entry accounts. For example, a machine manufactured or purchased is the cost of that investment financed by the savings as represented by the loans, which in theory represent the intermediation of savings. Only that, in the example above, where money was created at the bank manager’s discretion, where did those savings come from?
Savings equals personal floats plus company depreciation reserves
To unravel this riddle, you need to know that savings do not just represent the extra money balances in personal bank accounts, but also the money set aside by companies in the form of depreciation reserves. Companies thus earn money that is continuously being set aside as savings in the form of money that is eventually to be used to replace the capital asset once it is worn out in order to continue business as going concerns.
As consumer prices have risen due to the Central Bank providing more money balances than people wished to hold, that additional money that clearly flowed into the higher prices paid for consumption goods has ended up fully in the hands of the companies who need that money to replace their capital assets. In other words–and here is the kicker–the ownership of investment capital, a part of which was financed by the consumer through the higher consumer prices paid, has been fully transferred to the company owner! And Economists don’t ever pick this up in their statistics because they count consumption as consumption, without realizing that a portion of that consumption actually relates to a transfer of savings from consumers to capital owners. Nobody is ever the wiser. It’s a big racket with unconscious kickbacks being paid at the expense of consumers, increasing their costs. And it is not the rise in consumer prices per se that determines the extent of those kickbacks, but the prices relative to what they would have been had that unwanted additional amount of money never been created in the first place. And who can see what such prices would have been?
Essentially, the ownership of savings has been surreptitiously transferred from consumers to capital owners subverting the whole rationale and reason d’etre for saving. What do I mean by this? I mean that one generally saves to spend in the future. If you have saved and your savings are taken away from you, what do you have left over to spend in the future?
Sure, companies have the money, which they need to replace their capital. But what if they’ve produced too much capital, only needing to replace it so much later because they were pumped up with exuberant expectations of what they could sell based on a demand that was simply not sustainable.
Do you see that it could have been sustainable had they at least left the ownership of the savings in the hands of the true savers? Consumers would then have the means to spend by drawing on those savings irrespective of the question of capital replacement expenditure that has now been delayed due to Central Bank karma that had pushed all that over-investment just to get a kick out of the dog sleeping under the CPI. One that barely manages a feeble bark after this game has gone on for long enough.
In the next article to this series, we will take a look at how the actions of the Central Bank have led to indebting the consumer in an attempt to tread water against the law of karma, by trying to hold up what is unsustainable and being in denial of its contribution towards unsustainable levels of investment and long run employment. Economists judge consumers as simply irrational for getting themselves into too much debt without realizing their role in facilitating such behavior, which, if it had not actually occurred, would have exposed the Central Bank Emperor not wearing any clothes much sooner. We will also revisit the impact on secondary market asset values hinted at in the second article to this series.
Robert Wutscher is an independent researcher.