Index

5: Part 2: What We Must Learn from Social Credit

The following are extended excerpts from Understanding the Financial System: Social Credit Rediscovered by Frances Hutchinson (Jon Carpenter Publishing, 2010).

Chapter 3 — The Missing Economist

In the immediate aftermath of the First World War the Labour Party was just on the point of emerging as a major political force in UK politics. Trade Unionists, left-wing academics and potential politicians were being encouraged to study economics at institutions like the London School of Economics, founded in 1895, so that they could take their place in the establishment institutions of the nation state. At issue was the just or fair share of the proceeds of wealth creation due to the supposed creators of the wealth, the "workers" on the one hand, or the "capitalist" owners of land or capital on the other. Thus economics was used as the key to the justification for Labour's claim to a greater share of the wealth created by the capitalist system of industrialization. The party system lent itself to a polarized debate on the relative merits of the "working class" or the "capitalist class." In this scenario, Clifford Hugh Douglas' productions, based on his analysis of the institutions of finance, of economic depression and further world war were met with little enthusiasm. With hindsight, however, it is clear that Douglas's analysis provides a starting point for a comprehensive understanding of the workings of the economy as we knew it in the twentieth century. with all the drives to poverty amid plenty, ecological devastation, wasteful consumerism, and war.

The Financing of the First World War

Douglas' analysis of the relationship between finance and the processes of production and distribution arose from his detailed study of the financing of the First World War. Before war broke out, lack of finance was the major obstacle to construction of socially necessary infrastructure. At the same time, goods and services needed by the consuming public could only be produced and distributed on terms dictated by the availability of finance. However, as Douglas observed, war "is a consumer whose necessities are so imperative that they become superior to all questions of legal and financial restriction." In war, to maintain a connection between finance and production, the situation has to be reversed. Finance has to follow production instead of, as in accepted normal practice, production following finance.

The National Debt rose between August 1914 and December 1919 from about six hundred and sixty million sterling to about seven thousand seven hundred million sterling. And this rise represents, on the whole, the expenditure over that period which it was deemed impractical to recover in current taxation.

Douglas estimates the average taxation for war purposes over the period 1914-1918 at about £300M per annum. Roughly speaking, the amount paid by the public as consumer for the goods and services supplied to it for war, over the period of war, was about £1,350M. The financial cost of those goods and services was about £8,350M, a ratio of cost to price of 1:6. In other words, goods were sold to the public at one-sixth of their apparent financial value. As Douglas explained, "a great deal of the necessary money was created by what are known as the Ways and Means Accounts, and the working of this is described in the first report of the Committee on Currency and Foreign Exchanges, 1918, page two." Douglas' paraphrase of the report appears in Social Credit. Writing in 1919, Douglas summarized the situation. A sum of about eight thousand million pounds was spent during the war on services rendered and paid for, on munitions of all kinds produced and used up, leaving a War Debt to be repaid.

Now, the services have been rendered, and the munitions expended, consequently, the loan represents a lien with interest on the future activities of the community, in favour of the holders of the loan. The community guarantees the holders to work for them without payment, for an indefinite period in return for services rendered. What are those services?

Disregarding holdings under £1,000 and re-investment of pre-war assets, the great bulk of the loan represents purchases by large industrial and financial undertakings who obtained the money to buy by means of the creation and appropriation of credits at the expense of the community, through the agency of industrial accounting and bank finance.

Douglas concludes that the financier is usurping the function of the State in creating, in the form of debt, the credit necessary to fund the war. Credit is the possession of the community as a whole, and not that of a sectional interest group such as the bankers.

From his early observations of the financial mechanisms employed in the funding of the production of goods and services for the conduct of the First World War, Douglas developed his Social Credit analysis or the financing of production and distribution in "normal peace time." Throughout his writings Douglas stressed that blueprints and panaceas were to be avoided at all costs, since "every suggestion made in this connection has in view the maximum expansion of personal control of initiative and the minimization and final elimination of economic domination, either personal or through the agency of the State." In this, he was at complete variance with economic orthodoxy.

Economics in the Academy

Economics is the study of the monetized economy.… Thus the student embarking upon a study of economics is taught to distinguish between needs and wants. A need is a matter of opinion. A want, on the other hand, is a need backed by money so that it becomes a "demand," which is something scientifically recognizable. A demand is a measurable, non normative fact which can be studied by the economics profession and fed into models. Other factors, including human needs and environmental considerations can be factored in artificially as "external."

Economics studies the behaviour of 'economic man' in his pursuit of the maximization of satisfaction and minimization of effort: it is the science that deals with the production, distribution and consumption of material wealth as measured by money. According to economic theory, under division of labour in a perfectly free market, individuals will undertake a series of small tasks according to their skills and resources, to increase wealth. All have an obligation to participate in the general wealth creation, giving a corresponding right to a share of the increased wealth.

A number of "heterodox" schools of economics have evolved to challenge the basic assumptions of orthodoxy. Institutional/evolutionary economists factor in the existence of banking, legal, corporate and other institutional structures. Marxian economics follow Marx's development of the labour theory of value: as the capitalists appropriate surplus value from labour they accumulate wealth for future investment. Post-Keynesian economics explore macro-economic models, tending to reject the IS/LM (Investment Savings/Liquidity (preference) Money supply) model, but broadly accepting the basic tenets of economic orthodoxy. Feminist economics and environmental economics seeks to apply orthodox economic methodology to "women's" and "environmental" areas of concern. All these schools have raised fundamental issues about the relationship between the economy, the social orders and the natural order.

Economists of all types and persuasions have dedicated their lifetimes to the subject, producing a wealth of literature which makes fascinating reading. This all too brief summary of the broad field of economics is not designed to dismiss the volume of significant study of the economy which has been produced over the past two centuries. It is rather to place the "missing link" of Douglas Social Credit economics within the broad context of the study of economics.

The "Circular Flow"

Broadly speaking, orthodox economics is the study of the allocation of scarce resources to the satisfaction of infinite wants. The economics student is first instructed in the "micro economics" via the "Law of Markets" or "Say's Law" which derives from the writings of the French businessman and economist, Jean Baptiste Say (1767-1832).

According to this "Law," production creates its own demand: that is, when goods are produced and supplied to the market, the process automatically generates a demand for those goods.…

Households have what businesses demand, and businesses supply what households demand. People go to "work," supplying firms with labour land or capital if that is what they own) so that goods can be produced. According to this theory, recessions are not caused by a shortage of money, because the production of goods automatically distributes money, in the form of wages, salaries and dividends, with which to buy the goods. If demand is not sufficient, it may be because people are hoarding their money by saving it, or taxes are too high.

In that event, prosperity can only be increased by stimulating production, rather than consumption. The answer is not to create more money, because more money demanding the same quantity of goods does not create a real increase in demand: it merely results in inflation. In the face of the obvious fact of booms and slumps, modern Keynesian macro-economists have argued that Say's Law only applies when prices are fully flexible. In the short run, when prices are not flexible, a drop in aggregate demand can cause a recession. By the late twentieth century the obvious errors in even this interpretation of Say's original conceptualization of the "Circular Flow" have been noted by a few career economists. The circular flow model only conceivably "works" where both time and money are eliminated, so that exchange takes place under a barter system in which outputs remain exactly the same as inputs. It is an entirely static model: if anything changes, an entirely new frame has to be drawn.

The A + B Theorem

Douglas pointed out the obvious. Production takes place over time, and exchange takes place on the market for money. When these two facts are taken into account, it becomes necessary to view the "circular flow" more critically. At the point in time when businesses send finished consumer goods onto the market for sale, they have merely completed a process which may cover months or even years of the different stages from raw materials through to finished product, including the making of machines and the building of factories. Hence the wages, salaries, and dividends paid out at the point of sale will be less than the total prices of products going into the market at that point in time. Each business must cover the total costs of past production, or they will go out of business. The fact that a substantial part of the inputs to the firms do not come directly from the consuming "households," but take the form of capital or intermediate goods. drastically alters the usefulness of the circular flow concept. In Douglas' words:

"A factory or other productive organization has, besides its economic function; as a producer of goods, a financial aspect – it may be regarded on the one hand as a device for the distributing of purchasing power to individuals, through the distributing of purchasing power to individuals through wages, salaries and dividends; and on the other hand as a manufactory of prices – financial values. From this standpoint, the payments may be divided into two groups:

"Group A – All payments made to (wages, salaries, and dividends).

"Group B – All payments to other organizations (raw materials, bank charges and other external costs).

"Now the rate of flow of purchasing power to individuals is represented by A, but since all payments go into prices, the rate of flow of prices cannot be less than A+B. Since A will not purchase A+B a proportion of the product at least equivalent to B must be distributed by a form of purchasing power which is not comprised in the Description grouped under A."

The above statement of the A+B Theorem, originally published in 1920, was amplified in Douglas' Birmingham debate with Hawtrey in 1933 by the use of the Social Credit Analysis Diagrams.

The diagrams can usefully be compared with the conventional Circular Flow diagram. The key difference is that the Bank having been identified as the "money maker" is shown to have a crucial role to play in the whole scenario. Earners of wages, salaries and dividends get their money from a producer. Moreover, producers do not make money; banks make loans to productive organizations. Loan money flows from the bank to the producer, who passes on part of the total sum directly to the citizen as a wage or salary which can then be spent by the consumer in that productive period, Those "distributed costs" or "A" payments are available to be spent with the retailer so that in the course of time they return to the Bank. However, the producer must meet other "allocated costs" incurred from past stages of production, including costs of plant and raw materials. These "costs" or "B" payments are costs which each individual producer must meet over and above any payments distributed by that producer in the form of wages, salaries and dividends.

The producer cannot meet all costs until after all the goods are sold, i.e. the 'A' payments distributed before the goods are sold cannot be enough to meet the total costs. For the economy as a whole to function, new money has to be constantly produced by the Bank as debt, in respect of capital and intermediate goods which are not available for purchase in respect of capital and intermediate goods in the present period. As any child can tell, there is a very big difference between 'swapping' items on the one hand and buying and selling for money on the other. One sweet can be bartered directly for one biscuit. However, where money is concerned, child A can sell child B the biscuit for £2, buy the sweet for £1 and end up £1 the richer than before. Far from being incidental, money plays a central role not only in the economy, but in society as a whole.

Incomes — "A" Payments

According to mainstream conventional theory, all payments to "households" are being paid in the form of wages, salaries and dividends as rewards for inputs to the productive process. This means that money incomes to individual consumers are primarily conceived of as deriving from work undertaken in the service of the money economy. The logic of the scenario is that working for money is pure "disutility," an onerous duty for which a reward is given. In the same way, a dividend is paid to the "owner" of saved up financial capital which, when it is invested, brings a reward for the disadvantage of abstaining from earlier spending on consumer goods.

Going to work to earn the money to spend on the necessities and luxuries of life had, by the twentieth century, become so ingrained in the cultural psyche that it was difficult for people of all political persuasions who were doing well out of the system to begin to think laterally. Douglas's analysis was clear and to the point. In days gone by it was necessary to labour for long hours with hand tools in order to produce the basic requirements of human existence. With the new technologies, made possible through the division of labour, the link between "work" put in and money reward given became indistinct.…

As long ago as 1776, Adam Smith dramatically illustrated the principle of the "division of labour," whereby each worker specializes in one or a few functions of the production process within a particular trade or profession. Smith's example of the pin factory is often quoted but rarely studied for its far-reaching implications: a workman not educated to this business (which the division of labour has rendered a distinct trade), nor acquainted with the use of the machinery employed in it (to the invention of which the same division of labour has probably given occasion), could scarcely perhaps, with his utmost industry, make one pin a day, and certainly could not make twenty.

But in the way in which this business is now carried on, not only the whole work is a peculiar trade, but it is divided into a number of branches, of which the greater part are likewise peculiar trades. One man draws out the wire, another straightens it, a third cuts it, a fourth points it, a fifth grinds it at the top for receiving the head; to make the top requires two or three operations; to put it on is a peculiar business; to whiten the pins is another; it is even a trade in itself to put them into the paper; and the important business of making a pin, in this manner, is divided into about eighteen distinct operations which in some manufacturies are all performed by distinct hands, though in others the same man will sometimes perform two or three of them.… But though they were very poor, and therefore but indifferently accommodated with the necessary machinery, they could, when they exerted themselves, make among them about twelve pounds of pins a day. There are in a pound upwards of four thousand pins of middling size. Those ten persons could therefore make among them upward four thousand eight hundred pins in a day. But if they had all wrought separately and independently, and without any of them being educated to this particular business, they could not each of them have made twenty, perhaps not one pin a day.

The passage is revolutionary in its implications. If, by separating into different trades and professions, and specializing within each separate trade, pooling knowledge, expertise and invention, the total wealth of the entire economy is increased many thousand times over, calculation of money wages, the rewards rightly due to one individual worker in respect of his personal contribution to the total enterprise, must become a major issue for consideration.

The passage cited from Smith is followed by discussion of the degree of adaptability of different trades to the division of labour and hence to mechanical productive processes. Even at this early stage of the development of modern productive methods, Smith observed that agriculture was less suited to mechanization than other types of production, since the care of the lands, its plants and animals, necessitated a holistic approach which could not be quantified in the same way as the manufacture, e.g., of pins.

The men in the ten-men pin factory cited by Smith were "very poor," with little inclination to exert themselves. Smith was writing during the eighteenth century, during the early stages of industrialization, when landless labour was plentiful. Enclosures had continued to force people off the land, from which they had traditionally secured a living, so that men, women and children were employed for a pittance in mines and factories, working under appalling conditions. The only incentive to work was the reward, in money or in kind, which would supply the basic necessities of life. Under these circumstances, the demand for a fair day's wage for a fair day's work was logical and entirely reasonable.

National Dividend and the Common Cultural Inheritance

By the 1920s and 1930s, technological developments had reached the point where, in certain industries, machinery could perform most of the mechanical tasks previously undertaken by individual workers. The result was a plentiful flow of goods into existence, at prices covering the previous costs of production, but an inadequate flow of the finance to enable consumers to buy the newly available products. The option then was to jettison the labour-saving machinery and revert to manual labour and handicrafts to keep the labourers employed. In 1924, Douglas spelled out the necessity to re-think the relationship between finance and the social order.

The early Victorian political economists agreed in ascribing all "values" to three essentials: land, labour, and capital. But it is rapidly being recognized that, while there might have been a rough truth in this argument during the centuries prior to the industrial revolution after the inventive period of the Renaissance, and culminating in the steam engine, the spinning-jenny, and so forth, there is now a fourth factor in wealth production, by far exceeding that of the other three, and which may be expressed in the words of Mr. Thorstein Veblen as the "progress of the industrial arts." Quite clearly no one person can be said to have a monopoly share in this; it is the legacy of countless men and women, long since dead. And since it is a cultural legacy, it seems difficult to deny that the community, have rightful claim to participate in this inheritance. This could be recognizing by granting all citizens the inalienable right to a National Dividend.

A "dividend" in its accepted sense, is a payment of money; a "credit" which derives from the community but is paid through the banking system.… The institutions which mobilize the issue of "credit" are the banks and financial institutions. But what is "credit"?

Real and Financial Credit

Throughout the twentieth century individuals spent their lifetimes "earning" and spending "their" money. Yet most would find it very difficult to explain exactly what money is, how their employment generates an income, or what forces regulate the circulation and the amount of money in existence.

From the outset of his writings on the subject, Douglas distinguished between real and financial credit. At a point in time a community may have to hand all the physical and practical resources necessary for production, including land, raw materials, factories, machinery, power, skill, organization and labour. With a continuous supply of the means necessary for production, a plant could turn out a stream of goods. However, a year or two later, the same plant could be lying idle, while the "labour" was said to be "unemployed." What has happened to stop the wheels of industry turning? Clearly it is not a breakdown of the productive system, since tomorrow it could be set in motion again without the slightest difficulty. The plant lies idle because orders for the goods have ceased to come in. The problem is that need is not backed by money; it cannot be translated into effective demand. The question then is – why is money at one time plentiful and at another time scarce? Productive capacity certainly does not vary upwards and downwards at regular intervals.

On the contrary, the world's productive capacity has steadily and rapidly increased over the decades. The productive capacity of the industrialized world is hundreds of times today what it was a century ago, and is constantly increasing with every new invention. Not only are variations in the availability of money and its circulation through the economy not due to variations in productive capacity, they scarcely relate to production at all. The production of finance, on the other hand depends on factors over which the productive processes have little or no control. This discrepancy between goods and finance, between productivity and currency, is the difference between real credit and financial credit. Real credit rests on real resources – materials, power, labour and technology. Financial credit rests, ultimately, upon belief – credo – it is an article of faith. If the ownership of the means of direct production is in the hands of capitalists, the real controls still lies with finance, whose ultimate ownership is vested in the financial, and not in the productive system.

Douglas' analysis of one actual role of finance within the real economy of every day practice was at sharp variance with mainstream neoclassical orthodoxy. Economic "science" is almost exclusively concerned with accounting the distribution and income within a business community centered on the market. Thus orthodoxy reduces motivation to the pure calculation of profit or loss; the actions of individuals are informed by a very simple rule of thumb, that of pain-cost and pleasure-gain of "Rational Economic Man." However, although mainstream theorizing purports to focus upon the physical processes of production and consumption, it does so in a very confused manner: the theories of supply, of demand and price are based upon financial calculations and considerations. Thus businesses do not acquire finance to consume, but in order to acquire more finance from further sales.

[The question is, why has demand ceased if the products in question are needed? The problem is that need is not backed by money: it cannot be translated into effective demand. The question is, why has demand ceased if the products in question are needed? The question then is – why is money at one time plentiful and at another time scarce? Productive capacity certainly does not vary upwards and downwards at regular intervals. On the contrary, the world's productive capacity has steadily and rapidly increased over the decades. The productive capacity of the industrialized world is hundreds of times today what it was a century ago, and is constantly increasing with every new invention. It can be stated with all certainty, therefore, that the variations in the availability of money and its circulation through the economy are not due to variations in productive capacity, they scarcely relate to production at all.

The production of goods depends upon the availability of real resources; the production of finance, on the other hand, depends on factors over which the productive processes have little or no control. This discrepancy between goods and finance, between productivity and currency, is the difference between real credit and financial credit. Real credit rests on real resources – materials, power, labour and technology. Financial credit rests, ultimately, upon belief – credo – it is an article of faith. If the ownership of the means of direct production is in the hands of the capitalists, the real control still lies with finance…whose ultimate ownership is vested in the financial, and not the productive system.

Douglas's analysis of the actual role of finance within the real economy of everyday practice was at sharp variance with mainstream neoclassical orthodoxy. Economic science is almost exclusively concerned with accounting the distribution of ownership and income within a business community centered on the market. Thus orthodoxy reduces motivation to the pure calculation of profit or loss; the actions of individuals are informed by a very simple rule of thumb, that of pain-cost and pleasure-gain of "Rational Economic Man."

However, although mainstream theorizing purports to focus upon the physical processes of production and consumption of material goods it does so in a very confused manner: the theories of supply and demand and price are based upon financial calculations and considerations. Thus businesses do not acquire finance in order to consume, but to acquire more finance from further sales, which is a very different matter.…

The passage is revolutionary in its implications. If, by separating into different trades and professions, and specializing within each separate trade, pooling knowledge, expertise and invention, the total wealth of the economy is increased many thousand, the rewards rightly due to times over, calculation of money wages due to one individual worker in respect of his personal contribution to the total enterprise, must become a major issue for consideration.]

Free Social Credit

A credit is "free" in form when a Credit Authority transfers it to some recipient without requiring the recipient to pay interest on it. Is such a gift of credit essentially a loan in perpetuity to the recipient?… If no interest is charged, and if no moral obligation on the part of the recipient to pay interest is recognized, there would seem no difference in form, either…. However, there remains a big distinction between such a loan and a gift. That lies in the attitude of mind involved.

That depends on whether the recipient is supposed to be under a moral obligation to return it, or has the moral right not to do so…. Fundamentally, interest is exactly like the seal on a legal document. It is a recognition in law of the acceptance by the borrower of the moral right of the lender to redeem the pledge.…

Douglas, the practical engineer, surveyed the workings of the financial system of the industrial world before, during, and after the First World War. He concluded that the indirect financing of distribution (incomes) through the debt-financing of employing institutions was an unnecessarily cumbersome and outmoded methodology. This chapter has provided a brief overview of the subject. There can be no substitute, however, for the critical study of Douglas' original works.

In post-industrial societies money forms the "life-blood" of the social order. It therefore follows that an understanding of finance within the institutional framework of society as a whole becomes an essential prerequisite for progress towards a sane, just and sustainable social order.

§     §     § §     §     § §     §     § §     §     §

In his earliest discussion with trade unionists and the Labour Party throughout the UK, Douglas constantly stressed the need to distinguish between money values and the practical realities of everyday economics.

Without the Douglas analysis, mainstream economic thought in the academy remains little more than an incoherent collection of non-sequiturs.

What has been attempted here is the briefest of summaries of Douglas' detailed analysis. Douglas' original work is essential reading if a full understanding of the technical details of the relationship between the financial and the real economies in the post-industrial era is to be achieved.

For Douglas and also for Veblen, the economy functions through a series of man-made institutions, the evolution of which can be studied for the introduction of sane, sensible adaptations which take account of all the factors concerned. Douglas provided clear and concise answers to the frequently asked questions about the working of the economy in the twentieth century. He was, however, persistently misinterpreted by career politicians, bankers and academics.

This was particularly true of socialists who assumed that Douglas might perhaps be advocating a version of state control of industry in general, and banking in particular. Hence Douglas found it necessary to clarify his stance.

William Krehm

-- from COMER, August 2011

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