Saturday, 21 August 2010

Costs and Time

By: Socred - B.A., SCMP

According to the generally accepted accounting principles, when physical capital is purchased, it is recorded as an asset and expensed over time as the capital depreciates. “Generally accepted accounting principles require expenditures to be capitalized when they will benefit more than one accounting period, and when they are significant in amount, and when they can be measured with reasonable objective evidence. (Financial Accounting, Henry Dauderis, pge. 393) With accrual accounting, revenues and expenses are recorded when they are incurred. Because capital depreciates over time, and has a longer life than the time at which it was purchased, physical assets are depreciated via depreciation expenses in order to better match costs with revenues. This defers financial costs to the future in order to “allocate costs over its (capital's) useful life”.

From an economic perspective, there are two ways of measuring costs: 1) financial costs, and 2) real costs. One of the purposes of cost accounting is to attempt to measure the real cost of production in terms of financial costs. Orthodox economics regard real costs as "the alternative opportunities forgone" (Hischleifer, "Price Theory and Applications, pge. 176). These costs are referred to as "opportunity costs", and this is what economists call the real cost of production. In other words, the real cost of producing something is the opportunity lost to produce something else. This theory of costs is unusable at the macro-economic level because it infers that the real cost of production is all the non-existent production that could have occured. This cost would be impossible to measure, because it would include all production which is non-existent. Douglas proposed that the real cost of production is consumption over an equivalent period of time. In other words, if we produce ten apples, and consume eight in the same period of time, the real cost of producing those ten apples was eight - profit was two apples. These two apples can then be exchanged for other goods in a barter economy. However, in the macro-economic sense, profit is pointless, since macro-economics is concerned with aggregates. As Douglas made explicit, the purpose of production is consumption (otherwise production is waste). In other words, real profit in the aggregate is merely waste, because it would be production which is not meant for consumption.

Now, the only time that exists is the present. The past used to exist, but it is gone. The future exists as possibility. Time flows from past to present, but consciousness can only exist in the present - in the now. Everything that we are concsious of must exist in the present. While this may seem self-evident, it has important economic implications in regards to costs, and the attempt to allocate financial costs over future time periods.

Financial costs are measured in the currency of the nation that is measuring them. For instance, in Canada, we measure costs in dollars. Douglas proposed that the physical currency in which we can measure costs is the “time – energy unit”. The time – energy unit is “potential effort over a definite period of time.” (Economic Democracy, pge. 100) Obviously, as improvements in process reduce the amount of time – energy units used to produce a unit of output, the real cost of production is diminished, because less inputs are used to produce a unit output.

However, if physical costs are associated with the time-energy unit of measurement, this means that time is an important factor in measuring physical costs. Since the only time that exists is the present, the only time energy units which available are present units. And since these are a measure of physical costs, the only physical costs that can exist are present costs. Past time energy units have been expensed, and future time energy units do not yet exist. In other words, the only financial costs that should exist are current costs. Past costs no longer exist.

If past costs no longer exist, then why are we forced to pay for capital that was built previously? How was the real cost of capital expensed at the time it was built?

Currently, we are forced to pay for capital twice. The accountant is mainly concerned with costs and their impact on price, but forgets that the upper limit of price is what an article will fetch on the open market. When capital is built, purchasing power (in the form of wages, salaries, and dividends) is disbursed to individuals who helped construct the capital. These individuals use that purchasing power to purchase current consumer goods coming onto the market. This activity has a tendency to inflate the price of consumer goods as this purchasing power is recouped from retailers who find that the effective demand for their product rising. In this way, the consumer pays for the capital at the time of its construction via the inflation of the price of consumer goods, and once again as the capital is depreciated over time via depreciation expenses. In fact, the inflationary effect of the construction of capital would be far worse if it were not for the negating effect on this process of improvements in efficiency which tends to reduce prices at the same time.

Since one dollar of income is only capable of defraying one dollar of cost(*read "The Alberta Postwar Construction Committee" posted on this blog), consumers eventually find that they do not have income necessary to defray these depreciation expenses in the future, because they have already used this income to purchase consumer goods at or near the time they received the income. This creates a gap between incomes and prices, and necessitates the further production of goods and services that the consumer is unable to consume in order to distribute the necessary income to purchase all of the consumer goods coming onto the market at some future point in time. Douglas exposed this gap in his A+B theorem.

The solution is not to change the way accountants allocate costs over time, because this is an accurate attempt to match costs with revenues, and is likely the only way many businesses would be able to operate at a profit. The solution entails distributing purchasing power to consumers in such a manner that said purchasing power does not form a part of costs, which is exactly what happens with respect to Douglas’s proposal for a compensated price.

The compensated price mechanism cancels costs at retail by reducing prices to consumers. This increases consumers' purchasing power. The mechanism is designed to equate production and consumption, and to allow financial costs to more accurately reflect the real cost of production. In this way, costs that have been capitalized, and really represent past consumption, can be eliminated in the current accounting period.

Monday, 22 March 2010





It is generally assumed that the purchasing power of money
is increased or decreased by its velocity of circulation. However,
this theory will not bear examination in the light of the facts regarding
the issue and withdrawal of money under the established system.

For purposes of analysis the following simple illustration of
the velocity of circulation theory will suffice:

A wage-earner A. uses a $10 bill of his income to buy two
pairs of shoes from a shoe merchant B., who immediately goes into the
adjoining store and spends the $10 to purchase some shirts from C.,
C in turn immediately goes across the street to grocer D. and buys
some provisions costing $10, grocer D. then takes the $10 bill across
to the local garage E., to buy some gasoline and oil.

The contention is that the $10 bill provided purchasing
power to the extent of $40 during the day by virtue of its "velocity of
circulation" in enabling $40 worth of goods to be purchased by consumers.
On the face of it this would appear to be the case, but on examination
it will be found to be a complete fallacy.

Because all money issued creates a debt of the corresponding
amount at its source of issue, for all practical purposes merchants
B., C., D., and E. can be assumed to be operating on credit loans
from their banks with some "savings" invested in their stock.

The proceeds of every sale they make can be divided into three
parts: (1) repayment of a bank loan before a new line of credit can
be obtained to replace stock, (2) payment of operating costs and
(3) net profit- i.e. personal income for services. Suppose that in
each case B.,C., D., and E. work on a 15% net profit. From each
purchase amounting to $10 they would be obliged to set aside - say,
$8.50 repayment of their bank loans for replacement of stock and overhead
costs, and only $1.50 as personal income.This is likewise true of C. and D. Therefore, by spending the $10 both of them created a liability against their future purchasing power.

When A. obtained the $10: in wages there was against it a
corresponding cost in the prices of goods coming on the market. This
liability must be kept in mind.

On buying the two pairs of shoes from B., A. surrendered his
right to $10 purchasing power and B. acquired the right to $1.50 of
this, the balance going for the repayment of his bank loan and cancellation
of the money as shown previously. (If he was operating on his
own capital it would make no difference, for the $8.50 would have to
go to the replacement of working capital with the same result.)

If B. does not repay his bank loan, but spends the whole $10,
he will have a liability of $8.50 outstading which will constitute
a debt against future purchasing power. In other words he will have
to sell over $50 worth of goods without getting any portion of it for
his own use in order to make good the deficit.

Thus while it is true that in the example quoted ,the $10
bill resulted in $40 worth of goods reaching consumers, there was
created a trail of debts against their future purchasing power amounting
to $10 (the liability against the original issue of the money) plus
$8.50 (B.'s undischarged liability) plus $8.5O (C.'s undischarged
liability) plus $8.50 (D.'s undischarged liability)- making a total
of $35.50. Suppose E. now meets his obligations of $8.S0, he retains
$1.50 as his net profit--:ie.,as purchasing power.

It will be evident that the effect is exactly the same as
if A. bought gasoline, etc., from E., and B. and C. and D had obtained
goods from each other "on time", pledging their future purchasing

The so-called "velocity of circulation" did not incredase purchasing power at all.
The fallacy in the theory lies in the incorrect assumption that money "circulates",wheras actually it is issued against production, and withdrawn as purchasing power as the goods are bought for consumption.

Saturday, 23 January 2010

Mr. Hawtrey's Giraffe


THE much-abused but resilient A + B theorem is still a thorn in Mr. Hawtrey's flesh, and he has what he evidently regards as a new and devastating criticism to make, since he makes it twice; once in the introduction to his book, and again in the chapter devoted to Social Credit. The argument is so neatly condensed in the introduction that it will serve well here to open the subject. This is what he says:

"The concept of a deficiency of purchasing power, on which the whole fabric of Social Credit is built, means two different things, and not merely different, but contrary. At one stage it means an excess of money over goods and a consequent dilution of purchasing power by a rise of price; at another stage it means an excess of goods over money. The tacit assumption in the mind of the supporter of social credit is that, if the excess of money over goods co-exists with the excess of goods over money, the deficiency of purchasing power is doubled. With this impregnable redoubt in the background the conflicts over the outworks are mere skirmishes. All the arguments of the orthodox economist are put out of court because he has missed this fundamental principle."

Dear Mr. Hawtrey. That last sentence is meant to be sarcastic, of course, but what a funny thing the subconscious is. Perhaps he had a fleeting memory of having said something three years before which contradicted his new argument. It is a fact that in his debate with Major Douglas at Birmingham he gave a brief outline of the best orthodox account of how goods and services are produced and distributed, while money is created, issued, withdrawn and destroyed, with a description of a period of inflation followed by deflation. It would be tempting to criticise this account, particularly where he begged the whole question which was being debated in one crisp sentence:

"Payments by one trader to another cancel out." But we are concerned here only with the concluding sentence: "This account of the relation of the credit system to productive activity differs from that of Major Douglas in that it reaches the conclusion that an excess of demand IS just as likely to occur as a deficiency."

Careful comparison of this conclusion with the new argument discloses that Mr. Hawtrey has discovered that the A + B theorem does take into account an "excess of demand," but that (oh, horror!) it treats it as a dilution of purchasing power. This Social Credit is even worse than he thought it was. The curious thing is that he admits, as will be seen, "the rise of prices which is caused by the dilution as a decrease or deficiency of buying power. That usage," he says, "is quite defensible, for the rise of prices does diminish the command over goods represented by a given money income."

It is as if Mr. Hawtrey, confronted by a giraffe, exclaimed, "There it is, but I don't believe it."

Now the curious thing is that Major Douglas actually supplied at Birmingham the clue to the reconciliation of the apparent contradiction that worries Mr. Hawtrey so much. He said:

"When Mr. Hawtrey says that it is possible to have an excess of demand, I think what he means is that it is possible to have an excess of demand for consumable goods, in which I agree with him. It is possible to have this excess of demand by making a large quantity of goods which are not intended to be sold to the public and using the purchasing power distributed in making these goods to buy consumable goods."

After that it was really rather criminal of Mr. Hawtrey to be so slipshod. He should at least have said "an excess of money over consumable goods." The whole passage is sloppily worded in the eyes of a Social Crediter, trained to accuracy of expression (note, for example, how he misuses that word "doubled"), but Mr. Hawtrey is an economist, and moreover could plead that the passage quoted is only in the introduction. That, however, is no excuse for leaving out the word "consumable." Besides, it is also left out in the main argument. Mr. Hawtrey begins his main argument on page 296 by summarising the A + B theorem (quoted in full below*). Summaries of the A + B theorem are frequently misleading, but, as Mr. Hawtrey's argument is not affected, there need be no complaint about this one in its context. He then makes a remark that calls for extended comment before proceeding to his main argument.

"The sentence 'A will not purchase A plus B,' has been taken both by critics and by supporters of Major Douglas to mean that there is an inherent deficiency of demand. This interpretation has derived support both from the nature of Major Douglas's remedy, since his subsidy takes the form of the creation of additional purchasing power, and also from some direct pronouncements of his own."

I should like to make a plea here for the King's English and for commonsense. A theorem is not a parable that it should require interpretation; it is a proposition which can be demonstrated by argument to be correct or incorrect. Mr. Hawtrey is engaged upon the attempt to disprove it, and it is his business to deal with what Major Douglas actually says and not with anybody else's so-called interpretation of it.

The sentence "A will not purchase A plus B" means one thing and one thing only.* Mr. Hawtrey, in the last sentence of his chapter, compares some of Major Douglas's calculations to a misprint in the multiplication table, but here we have simple addition and subtraction applied to symbols. Either A will or will not purchase A plus B. If not, then 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.

Very seriously indeed I suggest that Mr. Hawtrey read the theorem again carefully, and try to understand exactly what it says. It does not just say there is an inherent deficiency of demand, it says something subtly but vitally different from that. It says that there is an inherent deficiency of demand unless something is done to supplement it.

As a protagonist of the orthodox theory that the present financial system is self-liquidating, Mr. Hawtrey has to prove one or the other of two things. He has to prove that the rate of flow of purchasing power to individuals is not A but A plus B, or else that a proportion of the product at least equivalent to B is in fact distributed by a form of purchasing power not comprised in the descriptions grouped under A. In doing so it is not enough for him to make emphatic assertions on the strength of his eminence in the financial world. His theoretical position is that of an eminent professor of Newtonian physics confronted by the challenge of Einstein—orthodox but shaking. But his real position is much worse than that, for he has to defend a theory which is responsible for the existence of a National Debt of £8,000,000,000, with a third of the population unable to spend as much as 6s. a week on food, while measures for limiting the production of food and discouraging the import of food are in full swing for the purpose of protecting prices; to say nothing of other evils.

It will be his business to prove that any money apart from A which is used to purchase A + B has not left outstanding any cost which must still be defrayed, and that any cost that has been defrayed is not at the expense of another cost left outstanding. For example, on page 302, Mr. Hawtrey, dealing with the item of cost known as depreciation, says:

"If it is invested either in the business itself or through the investment market, it is made available directly or indirectly for the production of new capital equipment, which will generate [he, presumably, means 'distribute'] incomes. "Nevertheless investment is a separate act, without which the surplus depreciation allowance would tend to cause a deficiency of purchasing power. And it undoubtedly does sometimes happen that such funds, even if not accumulated in cash, are applied to paying off bank advances."

In fact it is admitted here that when a trader charges for depreciation in his price and obtains his price from the public, he does so at the expense of an equivalent deficiency of purchasing power to meet the price of all the goods that remain unsold. But the next point made is that the money so obtained may be distributed again in the production of new capital equipment. Quite so, and, so far as it is paid to individuals, it will be available to buy the unsold goods mentioned above. But it is included as a cost in the charge for new capital equipment which can be met only by the creation of new money. The deficiency has merely been transferred from one account to another.

Again, on this subject of depreciation he says:

"The practice of applying depreciation allowances to the repayment of bank advances is an absorption of cash. But the tendency to cause a deficiency of demand will be counteracted if the banks create equivalent advances in other directions. And this they will seek to do in order to maintain their advances in due proportion to their cash reserves."

Unfortunately for Mr. Hawtrey, this is a perfect example of the situation described by the A plus B theorem in actual operation. Here, in quantitative terms, is the situation he has described in respect of one only of the items included in Group B in the theorem.

The price of a batch of goods is A + B, and B is a depreciation charge. The purchasing power distributed in respect of it (according to Mr. Hawtrey) is A, but the trader gets his price A + B, so that the general pool of purchasing power, which we will call x is now x – B; a proportion of the general pool of goods at least equal to B must be distributed by a form of purchasing power to be described by Mr. Hawtrey. B has been cancelled by the bank and the deficiency remains unless, says Mr. Hawtrey, the banks create equivalent advances in other directions. That is to say, another trader gets a loan and the amount is B, which he uses in his business. He charges it all into his price, so that even if the general pool of purchasing power were thus increased from x - B to x, the price values attached to the general pool of goods have been increased by the same amount B and the original deficiency still remains. Worse, it has been augmented, for when the trader received the loan he used it to create two groups of costs, group A and group B, so that the general pool of pur¬chasing power is still something less than x though more than x - B. So Mr. Hawtrey has his work still to do, and has already made his position more difficult.

If he knew it, his position is impossible, for he has yet to face the fact that Major Douglas has shown in his various works the methods, the efficacy of which is steadily decreasing, by which the present lunatic financial system endeavours to provide the new money with which "a proportion of the product at least equal to B must be distributed," but to do so in such a manner that (a) the power to monetise the credit of the people does not pass out of the hands of the money monopoly which has filched it, (b) the monopoly retains control of the lives of individuals by dictating the terms on which they shall obtain the purchasing power which is their license to live (the most stringent condition being the nerve-shattering neces¬sity to compete for paid work in an employment market steadily depleted by technological improvement), and (c) the monopoly can dictate the policy of Governments who have to borrow all their funds from it and then compete with the price system to extract taxes from a pool of money insufficient to meet both, so that Governments can be solvent only when their people are insolvent.

From all of which it can be seen that Mr. Hawtrey is defending an irresponsible and tyrannical system of government by money. Which brings me back to the main argument once more.

Mr. Hawtrey's main argument must be stated in his own words:

"In the chapter following the enunciation of the A plus B formula he [Major Douglas] deals with the creation of credit. When a banker creates credit, for example, by allowing an overdraft, he enables production to take place. The borrower and those who supply him* get to work, and 'all those concerns are distributing purchasing power to individuals, in the form of wages and salaries, ahead of production, which causes a rise in the price of existing ultimate commodities, the only commodities that individuals buy' (page 33). This is the dilution of purchasing power already described in 'Economic Democracy.' Yet on this very same page the A plus B formula is summed up in the proposition 'that the current flow of wages, salaries and dividends is less, much less, than the current flow of price values of articles produced.' The former proposition asserts that there is an excess of purchasing power over goods, which forces up prices; the latter asserts that there is an excess of goods over purchasing power. How are they to be reconciled?"

After what has already been said every reader will be itching to point out to Mr. Hawtrey the enormity of his error. With apologies to them and in deference to him I must dot some i' s and cross some t's. Neither of the pro¬positions asserts either of the things he says they assert. The former is very precise and refers to a distribution of purchasing power ahead of production causing a rise in the prices of ultimate commodities. The latter refers to the current flow of wages, etc., being less than the current flow of price values of articles produced.

Purchasing power is not quite the same thing as money; it is money in relation to price. One pound is money and it has the power of purchasing five articles priced at four shillings, but only four if their price is raised to five shillings. Take Mr. Hawtrey's phrase, "an excess of goods over purchasing power." That is not what we should say; it is not precise—try it with five articles and a pound; you will find it depends on the price of the articles, and Mr. Hawtrey does not mention the price. What Major Douglas says is that the current flow of wages, etc., is less than that of prices of articles produced. That is precise – try it with five-articles-a-week-at-five-shillings and a-pound-a-week.

The two propositions that have to be reconciled for Mr. Hawtrey are not what he says they are. It is very easy for Mr. Hawtrey to be superior and devastating about propositions he has mangled to suit the easy flow of his pen. It would be very easy to score off him by rewriting the propositions in some way which suited me, so I invite the most careful and suspicious scrutiny of what I am about to say by way of reconciling two propositions which are made by Major Douglas.

They are two propositions, and they are separate. One is a major and the other a minor proposition. To take the major first, contained in the A + B theorem (quoted in full on page 561), it is contended that there is an inherent deficiency of purchasing power in relation to prices if purchasing power and prices are both regarded as a flow, which is the correct way to regard them, and is how Mr. Hawtrey regards them, as a subsequent quotation will show.

If we isolate a given period of time to illustrate the major deficiency we must at least compute the total book values of all consumable goods, and of all capital and intermediate goods produced in a given period of production, against the total of wages, salaries and dividends distributed in respect of production during the same period.

Let us suppose that in the period chosen the purchasing power distributed in respect of all production is sufficient to meet the prices (book values) of all finished consumable goods, and that they are all bought and consumed. This, I take it, is the situation which would satisfy Mr. Hawtrey's sense of fitness, and it leaves all the remaining goods unsold, but it also leaves outstanding all their book values, which the public will have to pay in the future, since all costs must be defrayed by the public. Now it may be true that purchasing power has been distributed in the past in respect of all these costs (as a matter of fact Mr. Hawtrey has already demonstrated that it is not true for those allocated costs called depreciation), but it is clearly irrelevant since it has already been withdrawn in previous periods in the purchase of consumable goods. In other words, the public has made the goods and paid for them, but the costs are still outstanding and a proportion of them will be included in the cost of goods produced in the next period, and the remainder in succeeding periods.

Since the economic system is a continuous process, successive periods flow into each other, so it must be regarded as a flow, and the A plus B theorem so describes it. The B costs referred to in it are the outstanding costs carried over into any period from previous periods plus any fresh allocated costs and costs in respect of semi-manufactures which the public does not buy.

But, says Mr. Hawtrey:

"To say that 'the wages and salaries (already insufficient to buy the whole production) tend to be diluted in value until they merely represent the subsistence allowance of the persons concerned' (page 34), does not help; the fact is that confusion has been introduced into the subject by Major Douglas's practice of describing the rise of prices which is caused by the dilution as a decrease or deficiency of purchasing power. That usage is in itself quite defensible, for the rise of prices does diminish the command over goods, represented by a given money income. But unfortunately the same expression, a deficiency of purchasing power, is equally appropriate to the case where there is a deficiency of incomes. In the one case a deficiency of purchasing power means an excess of demand in terms of money over supply at a given price level, in the other it means a deficiency of demand."

I am puzzled as to the exact shade of meaning intended by the word "unfortunately," but to return to the period already described, let us suppose that there has been an expansion of capital equipment (armaments, for example, or, if guns annoy Mr. Hawtrey, electric power stations or blast furnaces), so that there is distributed purchasing power in excess of available consumable goods at their book prices. This is the minor proposition at which Mr. Hawtrey boggles. Prices rise. That is to say, sellers add a fresh and profitable allocated cost to the previous book value. Purchasing power is diluted so that a pound, instead, say, of buying ten articles at two shillings, can buy only eight at half-a-crown.

Apart from the painful repercussions of this in the relations between capital and labour (resulting in rising costs), it is clear that the major deficiency has been aggravated (not doubled, Mr. Hawtrey). But what do the traders do with the extra profit? Briefly they do one of four things. They save it, which deprives some other seller of a market for the time being. Now or later they will part with it, however. They will most probably hastily pay back a pressing bank loan which, as Mr. Hawtrey puts it, is an "absorption of cash." Or they will go out and spend it, which is all right, of course; the price rise has merely transferred the right to consume to them. Or they will invest it in their own or some other business, which distributes part of it (the A part) but creates an equivalent A plus B cost. All these processes, except spending for consumption, aggravate the major deficiency; some more than others. Additionally, the "boom" conditions encourage the installation of new capital equipment, the purchasing power distributed in respect of which will augment the process just described, and the cost of which will be outstanding in the next period.

Now the following paragraph constitutes the entire argument that Mr. Hawtrey advances in support of the assertions he has made—based as we have seen on garbled paraphrasing of the opposing argument:

"In practice all stages of production are in operation simul¬taneously. Those which cause an excess of demand and those which cause an excess of supply tend to neutralise one another. But if we apply the same description, a deficiency of purchasing power, both to the rise of prices in the one case and to the shortage of money offered in the other, it is fatally easy to be misled into the idea that as each stage of production taken separately tends to cause a 'deficiency' of purchasing power, therefore when they co-exist they must reinforce one another."

Again, the use of the word "fatally" produces an odd qualm. It reminds me of Huxley's definition of a tragedy as "a theory killed by a fact." That is the classical or deductive standpoint. From the realist or inductive view, if a theory is wrong the discovery of the fact that kills it is a triumph. Fatally, fatally—what does it mean?

In any event a period in which purchasing power exceeds the prices of consumable goods, that is to say, a "boom" or inflationary period, does not in the world of hard fact occur simultaneously with a period in which purchasing power is less than the prices of consumable goods—a "depression" or deflationary period. Such periods, as is surely well known, alternate with each other to the glory of Mammon.
(To be concluded:)


A factory or other productive organisation 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 distribution of purchasing power to individuals, through the media of wages, salaries, and dividends; and on the other hand as a manufactory of prices—financial values. From this standpoint its payments may be divided into two groups.

Group A.—All payments made to individuals (wages, salaries and dividends).

Group B.—All payments made to other organisations (raw materials, bank charges, and other external costs).

Now the rate of flow of purchasing power to individuals is repre¬sented by A, but since all payments go into prices, the rate of flow of prices cannot be less than A plus B. Since A will not purchase A plus 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. (Quoted from the Statement of Evidence submitted by Major C. H. Douglas to the Macmillan Committee on Finance and Industry, May, 1930.)