Sunday, 23 September 2012

Social Credit is Salvation Through Deflation

By: Socred - B.A., SCMP

One of the primary criticisms of Social Credit is that it is inflationary. Gary North has written a critique of Social Credit entitled “Salvation Through Inflation”. The purpose of this essay is to demonstrate the claims that Social Credit policies are inflationary are fallacious, and to demonstrate that its policies are in fact the only way to reduce prices given that labour is being replaced by capital in production. Economists define inflation as too much money chasing too few goods. They argue that an increase in the money supply with a relatively fixed amount of goods and services for sale tends to increase the price of those goods and services. This assumption is based upon the quantity theory of money, which is critiqued in another article on this blog.

Douglas said there were two forces that governed prices: 1) the upper limit of price is governed by supply and demand, or what the good or service will fetch on the open market, and 2) the lower limit of price is governed by the cost of production and the rules of cost accountancy. Economists focus solely on the forces of supply and demand and their effect on prices, but they tend to ignore the rules of accrual accounting and its effect on prices. As such, economists always see rising prices as a result of too much effective demand, which they believe is the result of too much money being created. Their only policy recommendation to eliminate, or reduce, inflation is to reduce the quantity of money being created. The quantity theory of money ignores how money is created by banks as a debt. It also ignores the fact that the creation of money for capital production is prior to said capital being able to produce any consumer goods.

When physical capital (machines, raw materials, factories etc…) is created it is generally financed through loans from banks. This increases the money supply at the time the capital is being constructed, and this money makes its way to consumers as effective demand through wages, salaries and dividends. Since the capital is being constructed, it is not capable of creating any new consumer goods, so the income disbursed in its creation makes its way to consumer goods and services already on the market. This has a tendency to inflate the price of those goods and services, and this is what economists would call “too much money chasing too few goods”. But is it too much money? The money disbursed via the construction of capital has to be given to consumers, because eventually said income will be part of the cost of that capital. If that money was not disbursed, consumers would not have enough income to pay for the capital as it was expensed at a later point in time. In other words, rising prices at the time capital is being created is not caused by “too much money”: it’s caused by income making its way to consumers prior to the capital being built being able to produce any consumer goods and services. This income is necessary to defray the cost of the capital being created, but it is not used to purchase the consumer goods said capital produces, because consumers have to use it to purchase goods and services at the time the capital is constructed in order to meet the needs of living.

Once the capital is constructed its costs are generally capitalized and expensed over a period of time using the rules of accrual accounting. Douglas’s A+B theorem divides costs into two categories: 1) A = income = wages, salaries and dividends, and 2) B = payments to other organizations. Over any given time an organization will distribute A in income and charge A+B in prices. This is true for all organizations. Consequently if we sum all of the income disbursed in an economy over a period of time it will always be less than the total prices generated over the same period of time. If this is true, how has the economy not collapsed? It has not collapsed because income in the creation of capital is distributed prior to the capital’s costs entering the market and being charged to the consumer. So long as capital is being created, and debt/money is increasing in order to finance its creation, the economy functions fairly well. As soon as the capital’s costs enter the costs of consumer goods, income is insufficient to defray those costs, unless more capital is being contructed, because the income disbursed to create the capital was used to purchase consumer goods at the time the capital was created.

As labour is displaced in production by capital, B costs increase relative to A costs. How does this influence prices? Price = A+B, and if B is increasing relative to A, then any attempt to stabilize or increase A (income) has to be met with rising prices. Conversely, any attempt to stabilize prices (A+B) has to be met by falling incomes (A). In other words, even if there’s not “too much money chasing too few goods”, prices will rise so long as the government tries to stabilize or increase incomes. Inflation is systemic given the rules of cost accountancy coupled with the fact that labour is being replaced by capital in production and a policy of full employment is being pursued. This is why the government accepts “limited” inflation: they are afraid of the effects of reducing prices will have on people’s incomes and economic activity.

Fortunately, there is a solution, and it’s the only mathematically viable solution. The solution is reduce prices at the point of retail with monies with no cost attached to them. If money passes through the productive system, it has to have a cost attached to it, but if the money is given directly to the consumer it does not. Prices can be reduced to the consumer via a price rebate distributed with debt/cost free money given to the consumer. For instance, if the price of the good or service is $100 and the rebate to the consumer is $25, then the price of the good/service has been reduced by $25 to $75. The retailer receives $100 and the consumer pays $75 – the difference is made up via the creation of new debt free money.

In summary, prices are governed by two limits – supply and demand and the cost of production. The quantity theory of money, and the belief that inflation is only caused by too much money chasing too few goods, focuses solely on supply and demand and assumes that prices are only governed by these factors. However, prices are also governed by costs and the rules of accrual accounting. The fact that labour is being displaced in production, combined with a policy of full employment, increases the costs of production and consquently prices, even though consumers have inadequate incomes to purchase all of production. The only way to eliminate this type of inflation is to give consumers a price rebate at the point of retail. Therefore, not only is Social Credit not inflationary, but its policies are the only viable way to eliminate the real cause of most inflation today which is the displacement of labour in production coupled with full employment policies.