By: Socred - B.A., SCMP
Douglas’s A+B theorem is probably the most simple, yet most controversial, of all of Douglas's ideas. Oftentimes, too much emphasis has been placed on this theory amongst Social Crediters themselves, but the theory itself is essential for understanding Douglas’ monetary policies. The theorem is a truism; however, the controversy lies in the nature of the “B payments” which Douglas identified. The theorem is stated by Douglas as follows:
“In any manufacturing undertaking the payments made may be divided into two groups: Group A: Payments made to individuals as wages, salaries, and dividends; Group B: Payments made to other organizations for raw materials, bank charges and other external costs. The rate of distribution of purchasing power to individuals is represented by A, but since all payments go into prices, the rate of generation 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.” (C.H. Douglas, “The Monopoly of Credit”)
Douglas was an engineer, and a cost accountant.. As a scientist, he started with an observation, and formed a hypothesis. This is different than many orthodox economists who form a hypothesis, and then try to make the facts fit their theory. Douglas’ A+B theory is a simple statement of fact, and the accounts of any business will verify this fact. The confusion amongst orthodox economists lies in the nature of the B payments, and what causes them.
The critics of the theory generally fall into two categories by arguing: 1) B payments are really income, so there is no differentiation between A and B payments or 2) B payments are either past, or future, income. Let’s address both these criticisms individually.
The first criticism, which states that B payments are income, implicitly assumes the quantity theory of money. According to this theory, all money received by firms is income and can be used to purchase other goods and services. The theorem states that the quantity of transactions, multiplied by the quantity of money, equals total purchasing power. On the surface, this theory seems to make sense, but upon further investigation, it is not a reflection of reality. In reality, firms have costs that must be repaid. These costs can ultimately be traced back to bank debt because all money originates as debt. If a company receives $10 for its product, and assuming accumulated costs of $8.50 to acquire and sell this product, then only $1.50 is actually profit to the company, and potential income. The $8.50 must be used to cancel debts, or replace working capital. All of the $10 received by the company is not income. The fallacy was pointed out in "The Alberta Post-War Reconstruction Committee Report".
“The fallacy in the theory lies in the incorrect assumption that money "circulates", whereas it is issued against production, and withdrawn as purchasing power as the goods are bought for consumption. “ ( “The Alberta Post-War Reconstruction Committee Report of the Subcommittee on Finance")
The truth is that money does not “circulate” but instead operates in an accounting cycle, and B payments are monies on their way back to the bank, thus completing the cycle. Therefore, B payments do not exist as income to anyone. Income, by contrast, is flowing from the bank, and reaches individuals through the media of wages, salaries, and dividends. The argument that B payments are income is a complete fallacy based on the erroneous assumption that the circulation of money increases its purchasing power.
The second criticism, which has more credibility, will be seen to be a complete fallacy when the concept of time is introduced. Although not all B payments represent previous, or future, income (something we will touch on later), it is true that a proportion of the B payments are represented by past and future incomes. However; income and prices must be regarded as flows, and as Douglas stated:
“The mill will never grind with water that has passed, and unless it can be shown, as it certainly cannot be shown, that all these sums distributed in respect of the production of intermediate products are actually saved up, not in the form of securities, but in the form of actual purchasing power, we are obliged to assume what I believe to be true, that the rate of flow of purchasing power derived from the normal and theoretical operation of the existing price system is always less than that of the generation of prices within the same period of time.” (C.H. Douglas, “The Monopoly of Credit”)
It is obvious that future incomes cannot be used as present incomes (excluding momentarily credit from an extraneous source, which is a mortgage on future incomes). These future incomes are profits (interest on loans representing bank profit), which become future incomes via dividends paid to individuals. The fact that profits partially cause the gap between income and prices forms the supposed justification for the socialist argument against profits. However, nobody will do something unless it in some sense of the word profits him. Also, profits only represent a portion of the gap between income and prices. Douglas did not seek to eliminate profits, instead he wanted to compensate for the gap between income and prices which profits helped create.
"The essential point to notice, however, is not the profit, but that he cannot and will not produce unless his expenses on the average are not more than covered. These expenses may be of various descriptions, but they can all be resolved ultimately into labour charges of some sort (a fact which incidentally is responsible for the fallacy that labour, by which is meant the labour of the present population of the world, produces all wealth). Consider what this means. All past labour, represented by money charges, goes into cost and so into price. But a great part of the product of his labour -that part which represents consumption and depreciation - has become useless, and disappeared." (C.H. Douglas, "The Control and Distribution of Production")
Past income used for consumption represents a substantial portion of the gap between income and prices. The belief that incomes disbursed in the past for capital production are all saved up in order to defray the costs associated with those incomes as they make their way into the cost of future consumer goods is a complete fallacy. People tend to spend their income on consumer goods in a relatively expeditious fashion. This money is collected from the consumers by businesses through the agency of prices. The upper limit of prices being governed by the laws of supply and demand, or what the item will fetch. This income, recollected by businesses, forms a part of their profit, assuming they can sell their product above cost. These profits can be distributed as income in the form of dividends, but is most often re-invested back into the company, and therefore, do not exist as income to anyone.
“Consider the nature of these B payments. They are repayments collected from the public of purchasing power in respect of production not yet delivered to the public. If the wage earners in process ‘I’ use their current month’s, i.e. May’s, wages to buy their share of one current month’s production of consumable goods, they are using money distributed in respect of production which will not appear as consumable goods till October. They are in fact involuntarily reinvesting their money in industry, with the results previously explained” (C.H. Douglas, “The Monopoly of Credit”)
Therefore, it can be seen that the criticisms of the A+B theorem are based on the fallacy known as the quantity theory of money, or they fail to take into account the effect of time on income and prices (i.e. they are static). Incomes and prices are flows, and any analysis into their nature must account for the dimension of time. Since prices include all payments made to individuals as income (A), as well as all overhead charges (B), we must understand what causes these overhead charges in order to understand why prices rise faster than incomes when regarded as a flow.
"It is now necessary to see to what extent this conception of overhead charges can be extended, and I think that a little consideration will make it clear that in this sense an overhead charge is any charge in respect of which the actual distributed purchasing power does not still exist, and that practically this means any charge created at a further distance in the past than the period of cyclic rate of circulation of money. There is no fundamental difference between tools and intermediate products, and the latter may therefore be included." (C.H. Douglas, "The New and The Old Economics")
The cyclic rate of purchasing power of money can be calculated by calculating the average amount of deposits held by depositors in banks relative to the amount of clearings through the banks, minus the amount of "Butcher-Baker" transactions. Douglas referred to any transaction that broke a chain of repayments as a "Butcher-Baker" transaction. When a butcher receives money for his product from his customer, he must repay debts owed to the slaughterhouse for the meat, who in turn must pay debts owed to the farmer, who pays debts to the banker (all money originating from the bank as a debt). If the butcher buys bread from the baker with the money he has received from his customer, then he has broken the chain of debt to the slaughterhouse, farmer, and ultimately the banker; and therefore, these transactions leave a trail of debt, and must be deducted when calculating the cyclic rate of purchasing power, because the monetary cycle has not been completed. Douglas calculated the average cyclic rate of purchasing power to be approximately two and a half weeks in Britain ("The Old and the New Economics”). Therefore; any cost anterior to three weeks, must form a part of the gap between income and prices. Douglas spoke of this fact when questioned before the Alberta Agricultural Commission.
"Well, that question of course is outside what I was speaking of this morning, but I have no objection whatever to answering it shortly. The best way of understanding what the speaker has referred to as the "A plus B" theory is to look at the matter in this way: The purchasing power of the general community is practically 98 per cent, I think, taken over all products, bank money. The actual deposits in banks under what are sometimes called "normal times" (I don't know what normal times are, but they are frequently referred to so we will assume that there are normal times) the deposits remained fairly constant. For instance, in Great Britain since the war they have reached around between 16 and 18 hundred millions of pounds. Now there is quite obviously a circulation of those deposits through the agency of costs. They are distributed for wages and so forth and they come back to the same source through the agency of price. That is the way the existing financial system works.
Now all business in the world at the present time is carried on on the theory of the balanced budget, including governmental business. Therefore, you must have a right, or period of cycle through which this money which starts from the banks goes out through cost and comes back again to the banks through the agency of price; there must be a time that that cycle takes. Now we have as a matter of fact means of calculating that time, and in Great Britain the average is somewhere in the neighbourhood of around about three weeks. Now, so long as a charge is incurred and liquidated inside that period of three weeks it can be liquidated by that cycle of the flow of purchasing power, starting from the banks, going out through costs and coming back again through prices. So long as the whole transaction of costs and prices is involved in a period of about three weeks, there is no difficulty involved in the prices and the costs being equal, but any item of cost which is outside that period of three weeks we will say cannot be liquidated by that stream of credit which is constantly in circulation at a period rate, we will say of three weeks.
Now we know there are an increasing number of charges which originated from a period much anterior to three weeks, and included in those charges, as a matter of fact, are most of the charges made in, respect of purchases from one organization to another, but all such charges as capital charges (for instance, on a railway which was constructed a year, two years, three years, five or ten years ago, where charges are still extant), cannot be liquidated by a stream of purchasing power which does not increase in volume and which has a period of three weeks. The consequence is, you have a piling up of debt, you have in many cases a diminution of purchasing power being equivalent to the price of the goods for sale. It is frequently said, "Your theory must be absurd because we know that there are periods in which purchasing power is in excess of the price of the goods for sale, for instance at the end of a war." What people who say that forget is that we were piling up debt at that time at the rate of ten millions sterling a day and if it can be shown, and it can be shown, that we are increasing debt continuously by normal operation of the banking system and the financial system at the present time, then that is proof that we are not distributing purchasing power sufficient to buy the goods for sale at that time; otherwise we should not be increasing debt, and that is the situation." (C.H. Douglas, "Douglas System of Social Credit", evidence taken by the Agricultural Committee of the Alberta Legislature 1934)
If money disbursed for production makes its way to the bank before its cost can be extinguished in the price of the consumer goods it creates, then there is a corresponding gap between income and prices. If income is reinvested back into the productive system, then each time it is re-invested, it creates a new cost without creating new purchasing power (we have already seen that money does not circulate, but cycles, so money is only capable of cancelling one cost). The income I receive in terms of wages or salaries has been debited to the cost of some good or service. If I invest my income, then I expect to receive my investment back, with a rate of return. The only way the company I invested in can give me my money back with a rate of return is by charging the consumer through prices. Therefore; my income has created two costs: 1) the cost associated with the good or service that I helped provide, and 2) the cost associated with the investment that must be returned to me. However, my income can only cancel one of those costs. There is now a new cost created, without the creation of new purchasing power.
"But we also find that apart from this question of the distribution of purchasing power there is not enough purchasing power distributed to buy the goods which are for sale if the production of these goods has been financed by ordinary methods. There are many contributory causes to this situation, but it is probable that the main cause is due to the reappearance in prices of the same sum of money several times, a state of affairs which is rendered possible by the splitting up of production into a large number of processes." (C.H. Douglas, "Money and the Price System")
The reappearance in prices of the same sum of money several times creates a gap between purchasing power and prices. The re-investment of savings causes the reappearance in prices of the same sum of money, and the more production is split up into a large number of processes, the greater the probability that income disbursed in capital production will be reinvested. Douglas listed five causes of the gap between prices and purchasing power in "The New and The Old Economics":
"Categorically, there are at least the following five causes of a deficiency of purchasing power as compared with collective prices of goods for sale: -
1. Money profits collected from the public (interest is profit on an intangible)
2. Savings, i.e., mere abstentation from buying
3. Investment of savings in new works, which create a new cost without fresh purchasing power
4. Difference in circuit velocity between cost liquidation and price creation which results in charges being carried over into prices from a previous cost accountancy cycle. Practically all plant charges are of this nature, and all payments for material brought in frm a previous wage cycle are of the same nature.
5. Deflation, i.e. sale of securities by banks and recall of loans" (C.H. Douglas, "The New and The Old Economics")
We have already discussed at length reasons 1, 3, and 4. Reasons 2 and 5 are pretty much self-explanatory, both being a reduction in A, and not the creation of B costs. Add to all this the fact that overhead charges are growing in relation to income (i.e. B is increasing relative to A), due to the fact that capital is replacing the need for labour in the productive process, and it is apparent that the gap between income and prices is ever increasing, and this problem is ever worsening.
"At the moment the point to be borne in mind is that B is the financial representation of the lever of capital, and is constantly increasing in comparison with A. So that, in order to keep A and the goods purchase with A at a constant value, A+B must expand with every improvement of process..." (C.H. Douglas, "Credit-Power and Democracy")
What does this mean? If A+B must expand with every improvement of process in order to keep A, and the goods purchased with A ,at a constant value, and if A+B represent prices, then prices must expand with every improvement in process. This is why certain periods of time, when people have enough income to purchase most goods coming onto the market, are met with rising prices (i.e. inflation). Inflation is generally not caused by too much income chasing too few goods, but is caused by the ever increasing expansion of overhead costs via advancing technological processes. This means that inflation is inherent in our economic system, unless credit from an extraneous source is used to decrease, or stabilize, prices.
"Now any attempt, by current financial methods, to reduce prices (or even to stabilize them, as the phrase goes) is a mathematical absurdity unless the cost of this stabilization, or lowering of prices, is met from some extraneous source. Or to put the matter another way, the margin of profit which makes it possible for a producer to go on producing, disappears unless the financial cost, and consequently the price of production, is allowed to rise steadily in relation to direct labour cost." (C.H. Douglas, "Social Credit")
Sunday, 7 October 2007
Sunday, 20 May 2007
Industry, Income and Prices
By: Socred - B.A., SCMP
The monetary system and the productive system are two distinct factors in an economy. Therefore; we must inquire how the money system and the productive system are linked? What is the purpose of a productive system? And how does the productive system satisfy our needs?
"It must be borne steadily in mind in considering this question that the object of industry is not work for its own sake; the industrial system exists firstly because society has need of goods and services." (C.H. Douglas, "Credit-Power and Democracy")
The goal of the productive system is to create goods and services. The production of goods is the transformation of matter, and its movement to where it is demanded. Services enhance the value we attribute to goods. Work is merely a bye-product of this system. Therefore, the purpose of the industrial system is not to provide work; although, some work is necessary to provide the goods and services that we desire. The amount of labour required for production is constantly decreasing through advances in technology. Man organizes himself for productive purposes because we are capable of producing far more when we work together than if we were to attempt to produce individually. The increased output achieved by working together is known as the increment of association. This increment is dependent on available physical capital (raw materials, machines, buildings etc. ), technology and processes; most of which were built, invented, and developed, by people who are long since dead. The invention of the wheel, or the harnessing of fire, have both brought great benefit to mankind, but the people who developed these technologies are long since gone. These technologies, or processes, belong to every man by birthright, and form a part of our cultural heritage. Production is mostly a function of our cultural heritage. Direct labour is constantly becoming a less important factor in production.
"The modern producer-not so much of course, the agricultural producer, although to some extent that is true by the use of harvesters, and gang plows and many other things, application of transportation and so forth--but taken over the whole world, the actual producer so called is more and more the delegate of the general community, delegated as you might say, to press the keys of an enormous productive machine which is over-whelmingly effective as a result of inherited knowledge and technique. You can prove that to yourselves if you consider the effectiveness as producers of ten men, let us say in Detroit, and ten men on a desert island. What ten men on a desert island can do, is what they can do as producers; what ten men can produce in a year in the way of wealth in Detroit is due to their value as producers plus their application of the heritage of civilization, and I suppose ten men in Detroit could probably produce ten thousand times as much real wealth in a year as the same ten men on a desert island. The difference between that productivity is due not to their own virtues but to their inheritance of this technique of civilization." (C.H. Douglas, Testimony before the Alberta Agricultural Commission)
The cultural inheritance of the technique of civilization is primarily responsible for the wealth that we are capable of producing today. The current generation of men who "press the keys" of this enormous productive machine add very little to its productivity, and as Douglas said, if someone is sceptical of this fact, they should compare the productivity of ten men on a deserted island who do not have access to the cultural heritage, as opposed to ten men in Detroit who do. Of course, the machine would not produce at all without those who "press the keys", but the productivity of those who press the keys is mostly a function of our cultural heritage.
"The industrial machine is a lever, continuously being lengthened by progress, which enables the burden of Atlas to be lifted with ever-increasing ease. As the number of men required to work the lever decreases, so the number set free to lengthen it increases." ( C.H. Douglas, "Credit-Power and Democracy")
The industrial machine acts as a lever, which allows man to free himself from the burden of Adam, by substituting solar power for human power. Progress, or advances in technology, decrease the amount of labour it takes to produce goods or services. As the amount of men freed from production increases, via advances in technology, so the amount of men available to devise technology that is labour saving, is increased. As an example, the productivity of farmers has increased dramatically since the advent of the industrial revolution, and this has led to a drastic decrease in the amount of people engaged in agricultural production.
"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 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" ( C.H. Douglas, "Credit-Power and Democracy")
Companies have a dual role in the economy, because the modern economy is dependent on money for the distribution of goods and services. Firms not only create goods and services, but distribute incomes, at the same time creating price values. Income is distributed when a company pays wages and salaries to its employees, or distributes dividends to its owners, and that income is "repaid" when a consumer pays a price, thus acquiring a good or service in exchange for his money. We are now in a position to apprehend the accounting cycle of money. Money is created by banks through loans or overdrafts to businesses (excluding for the moment consumer debt), it is then distributed as income to workers, and owners, through the media of wages, salaries and dividends. It is eventually taken back in the form prices or taxes in exchange for a good or service,making its way back to the bank where the loan is repaid and, consequently, the money destroyed. Money operates in accounting cycle: it does not circulate. It is either creating costs or cancelling them. It has direction: it is either flowing from the bank and being distributed as income, or it is taken back as prices and flowing back to the bank (taxes being the government equivalent of prices) .
"It is a widely spread delusion that price is simply a question of supply and demand, whereas, of course, only the upper limit of price is thus governed, the lower limit, which under free competition would be the ruling limit, being fixed by cost plus the minimum profit which will provide a financial inducement to produce." (C.H. Douglas, "Economic Democracy")
Companies will not produce for any length of time below cost. Profit is the incentive to produce. Obviously, any price below cost results in a negative profit and a disincentive to produce. Retailers may sell some items below cost (known as "loss leaders") in the hope that they can sell other products above cost in order to compensate for that loss, but no company can produce below the total cost of production for any length of time. Hence; cost is the lower limit of price. The upper limit of price is what people are willing to pay, and the more they are willing to pay, the more profit. Often, firms will engage in "economic sabotage", or the artificial restriction of output, in order to sell at a higher price; thus maximizing their profit. This restriction is made easier when there is differentiation between products. For example, an individual farmer has no affect on the price of wheat by restricting his output, because wheat is a homogeneous product. Consequently; the price of wheat is often at or below the cost of production. However; a Mazzerati can be sold well above the cost of production by merely limiting the amount of Mazzeratis produced: creating an artificial scarcity. If effective demand is well above the ability of all producers to supply consumer goods, then the price of all goods will eventually rise regardless of the ability to create artificial scarcity. This situation is also known as inflation.
"The essential point to notice, however, is not the profit, but that he cannot and will not produce unless his expenses on the average are not more than covered. These expenses may be of various descriptions, but they can all be resolved ultimately into labour charges of some sort (a fact which incidentally is responsible for the fallacy that labour, by which is meant the labour of the present population of the world, produces all wealth). Consider what this means. All past labour, represented by money charges, goes into cost and so into price. But a great part of the product of his labour -that part which represents consumption and depreciation - has become useless, and disappeared." (C.H. Douglas, "The Control and Distribution of Production")
All costs go into price, and represent the lower limit of price. And all costs can ultimately be resolved into labour charges of some sort. However; the portion of the labour that represents past consumption and depreciation is no longer income. The problem is clear: cost forms the lower limit of price, and all costs go into prices: these prices are paid by incomes, but the portion of cost represented by consumption and depreciation does not exist as income. Therefore, total incomes are less than total costs. If every firm sold their product at cost (i.e. without profit), total incomes would be incapable of purchasing all the products that are produced. This fundamental flaw would have been exposed a long time ago if it were not for an intervening factor - credit from an extraneous source. An obvious extraneous source of credit is consumer credit, which is really a mortgage on future incomes, and only goes to exacerbate the problem as future incomes are decreased by an equivalent amount. However; the gap is mainly hidden by capital production and exportation of product. There are two types of goods: 1) Consumer goods, and 2) Capital goods. Consumer goods are purchased by consumers and their cost is defrayed upon purchase. Capital goods are purchased by businesses in order to produce consumer goods. Capital goods are raw materials, buildings, equipment etc., and their cost is not defrayed upon purchase, but transferred, and the cost ultimately ends up in the cost of a consumer good, where it is eventually defrayed upon purchase by a consumer.
"In consequence, the production which is stimulated - the production which we are asked to increase - is that which is required by the industrial machine, intermediate products or semi-manufactures, not that required by humanity." (C.H. Douglas, "The Control and Distribution of Production")
The cost of capital production showing up in the cost of consumer goods is delayed, because it takes time for a capital good to make its way through productive system in order to be consumed. This fact allows the income from capital production to cover the gap between income and prices on consumer goods. In fact, massive amounts of capital production can lead to inflation in prices of consumer goods, if the effective demand created through capital production is in excess of this gap. Alberta is experiencing this situation currently, as capital production in heavy oil upgraders is dispersing massive amounts of income leading to the inflation of prices - especially for consumer goods whose supply increases slowly (i.e. housing). However; the cost of these capital projects eventually make their way into the cost of a consumer goods (i.e. the cost of the upgraders will eventually be included in the cost of gasoline), and if the money disbursed as income for these capital goods is used on current consumption (which it most likely the case), then it will not be available to meet the price of the consumer good created at a future date. By attempting to close the gap between income and prices of consumer goods through capital production, we are exacerbating the problem, as the gap between income and prices of consumer goods only widens at a future date. When there is a lack of capital production (i.e. investment), firms find their margins decreasing, and we experience a business "slump".
"In other words, it is quite immaterial how many commodities there are in the world, the general public cannot touch them without doing more work and producing more commodities." (C.H. Douglas, "The Control and Distribution of Production")
Regardless of how many consumer goods are in existence, we are unable to purchase them unless we engage in capital production (i.e. there has to be sufficient investment to cover the gap between prices and income), or we engage in a policy of a "favorable balance of trade" (i.e. exports exceed imports) with other nations, disposing of production (i.e. doing more work than is necessary) in order to close the gap between income and prices . The more we engage in capital production, the more we are forced to seek a favorable balance of trade with other nations. This is a vicious cycle, because if we don't engage in excess capital production, or dispose of production by sending it to another country, companies find their margins decreasing, which in turn leads to layoffs, and a recession. However; it is impossible to keep following this path, because increasing investment ultimately leads to inflation as capital production makes its way into the cost of consumer goods, and all industrialized countries are seeking to continuously export their surplus production to foreign nations, which leads to ever increasing third world debt, and friction between industrialized nations, ultimately leading to war. Capitalism is plagued by periods of heavy investment, followed by rising prices, increasing interest rates in order to control prices, decreasing profit margins to businesses, unemployment, and finally a recession. In fact, some people have come to believe that this is a naturally occurring phenomenon like the rising of the sun or the law of gravity: what goes up must come down.
"By an accounting method of analysis, the conclusion is reached that the value, at the current retail price-level, of goods produced far exceeds the flow of purchasing-power from permanent sources. In other words, recurring periods of business depression are shown to be the result of present financial and business policies." (C.H. Douglas, "Social Credit")
Business cycles are simply caused by financial and business policy, and unless there is a change in our policy towards incomes and prices, this will be a recurring problem with our economic system. Attempts to close the gap between income and prices by increasing income through investment simply results in inflation: attempts to close the gap by giving surplus production to foreign nations leads to the struggle for markets, resulting in third world debt, friction between industrialized nations, and ultimately war. Attempts to reduce prices by restricting credit through increasing interest rates is also doomed to failure, because the upper limit of price is governed by the law of supply and demand, but the lower limit is governed by cost of production. It is the rising cost of production that is the primary culprit for inflation, not too much income. If effective demand is insufficient to cover the cost of production, plus the profit margin just large enough to provide incentive to produce, businesses will simply stop producing. This policy leads to bankruptcies and economic hardship.
"Now any attempt, by current financial methods, to reduce prices (or even to stabilise them, as the phrase goes) is a mathematical absurdity unless the cost of this stabilisation, or lowering of prices, is met from some extraneous source. Or to put the matter another way, the margin of profit which makes it possible for a producer to go on producing, disappears unless the financial cost, and consequently the price of production, is allowed to rise steadily in relation to direct labour cost." (C.H. Douglas, "Social Credit")
Central Banks attempts to arrest inflation through the use of interest rates to restrict the supply of money is futile, since it does not deal with the root cause of inflation, making the cure worse than the disease. The artificial restriction of credit causes margins to decrease leading to decreased production, which explains the common fallacy that there is a natural trade-off between inflation and decreased production. In reality, there is no trade-off. Prices can decrease, and production can increase, if part of the cost of production is defrayed with money that did not come from the productive system. Every debt created in the aid of production creates an equivalent cost, because the debt must be repaid. Debt is recovered in prices.
"the consumer cannot possibly obtain the advantage of improved process in the form of correspondingly lower prices, nor can he expect stable prices under stationary processes of production, nor can he obtain any control over the programme of production, unless he is provided with a supply of purchasing-power which is not included in the price of the goods produced. If the producer or distributor sells at a loss, this loss forms such a supply of purchasing-power to the consumer; but if the producer and distributor are not to sell at a loss, this supply of purchasing-power must be derived from some other source. There is only one source from which it can be derived, and that is the same source which enables a bank to lend more money than it originally received. That is to say, the general credit." (C.H. Douglas, "Social Credit")
Mankind will never have control over production, or stable prices, unless we are provided with a steady supply of purchasing power not included in the cost of goods sold. This purchasing power must be created debt free, and given to individuals in such a way that it's not derived from work, for all debt servicing charges, and labour costs, go into the cost of goods sold, and consequently, into price. In this way, improvement in processes, which decrease the real cost of production (i.e. the amount of energy used), will also reduce the financial cost of production, resulting in falling prices. By providing debt free credit to consumers in reduction of prices, and by virtue of a dividend not associated with work, not only will prices fall, but consumers will finally have control over production, and no longer will the productive system have control over mankind.
The monetary system and the productive system are two distinct factors in an economy. Therefore; we must inquire how the money system and the productive system are linked? What is the purpose of a productive system? And how does the productive system satisfy our needs?
"It must be borne steadily in mind in considering this question that the object of industry is not work for its own sake; the industrial system exists firstly because society has need of goods and services." (C.H. Douglas, "Credit-Power and Democracy")
The goal of the productive system is to create goods and services. The production of goods is the transformation of matter, and its movement to where it is demanded. Services enhance the value we attribute to goods. Work is merely a bye-product of this system. Therefore, the purpose of the industrial system is not to provide work; although, some work is necessary to provide the goods and services that we desire. The amount of labour required for production is constantly decreasing through advances in technology. Man organizes himself for productive purposes because we are capable of producing far more when we work together than if we were to attempt to produce individually. The increased output achieved by working together is known as the increment of association. This increment is dependent on available physical capital (raw materials, machines, buildings etc. ), technology and processes; most of which were built, invented, and developed, by people who are long since dead. The invention of the wheel, or the harnessing of fire, have both brought great benefit to mankind, but the people who developed these technologies are long since gone. These technologies, or processes, belong to every man by birthright, and form a part of our cultural heritage. Production is mostly a function of our cultural heritage. Direct labour is constantly becoming a less important factor in production.
"The modern producer-not so much of course, the agricultural producer, although to some extent that is true by the use of harvesters, and gang plows and many other things, application of transportation and so forth--but taken over the whole world, the actual producer so called is more and more the delegate of the general community, delegated as you might say, to press the keys of an enormous productive machine which is over-whelmingly effective as a result of inherited knowledge and technique. You can prove that to yourselves if you consider the effectiveness as producers of ten men, let us say in Detroit, and ten men on a desert island. What ten men on a desert island can do, is what they can do as producers; what ten men can produce in a year in the way of wealth in Detroit is due to their value as producers plus their application of the heritage of civilization, and I suppose ten men in Detroit could probably produce ten thousand times as much real wealth in a year as the same ten men on a desert island. The difference between that productivity is due not to their own virtues but to their inheritance of this technique of civilization." (C.H. Douglas, Testimony before the Alberta Agricultural Commission)
The cultural inheritance of the technique of civilization is primarily responsible for the wealth that we are capable of producing today. The current generation of men who "press the keys" of this enormous productive machine add very little to its productivity, and as Douglas said, if someone is sceptical of this fact, they should compare the productivity of ten men on a deserted island who do not have access to the cultural heritage, as opposed to ten men in Detroit who do. Of course, the machine would not produce at all without those who "press the keys", but the productivity of those who press the keys is mostly a function of our cultural heritage.
"The industrial machine is a lever, continuously being lengthened by progress, which enables the burden of Atlas to be lifted with ever-increasing ease. As the number of men required to work the lever decreases, so the number set free to lengthen it increases." ( C.H. Douglas, "Credit-Power and Democracy")
The industrial machine acts as a lever, which allows man to free himself from the burden of Adam, by substituting solar power for human power. Progress, or advances in technology, decrease the amount of labour it takes to produce goods or services. As the amount of men freed from production increases, via advances in technology, so the amount of men available to devise technology that is labour saving, is increased. As an example, the productivity of farmers has increased dramatically since the advent of the industrial revolution, and this has led to a drastic decrease in the amount of people engaged in agricultural production.
"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 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" ( C.H. Douglas, "Credit-Power and Democracy")
Companies have a dual role in the economy, because the modern economy is dependent on money for the distribution of goods and services. Firms not only create goods and services, but distribute incomes, at the same time creating price values. Income is distributed when a company pays wages and salaries to its employees, or distributes dividends to its owners, and that income is "repaid" when a consumer pays a price, thus acquiring a good or service in exchange for his money. We are now in a position to apprehend the accounting cycle of money. Money is created by banks through loans or overdrafts to businesses (excluding for the moment consumer debt), it is then distributed as income to workers, and owners, through the media of wages, salaries and dividends. It is eventually taken back in the form prices or taxes in exchange for a good or service,making its way back to the bank where the loan is repaid and, consequently, the money destroyed. Money operates in accounting cycle: it does not circulate. It is either creating costs or cancelling them. It has direction: it is either flowing from the bank and being distributed as income, or it is taken back as prices and flowing back to the bank (taxes being the government equivalent of prices) .
"It is a widely spread delusion that price is simply a question of supply and demand, whereas, of course, only the upper limit of price is thus governed, the lower limit, which under free competition would be the ruling limit, being fixed by cost plus the minimum profit which will provide a financial inducement to produce." (C.H. Douglas, "Economic Democracy")
Companies will not produce for any length of time below cost. Profit is the incentive to produce. Obviously, any price below cost results in a negative profit and a disincentive to produce. Retailers may sell some items below cost (known as "loss leaders") in the hope that they can sell other products above cost in order to compensate for that loss, but no company can produce below the total cost of production for any length of time. Hence; cost is the lower limit of price. The upper limit of price is what people are willing to pay, and the more they are willing to pay, the more profit. Often, firms will engage in "economic sabotage", or the artificial restriction of output, in order to sell at a higher price; thus maximizing their profit. This restriction is made easier when there is differentiation between products. For example, an individual farmer has no affect on the price of wheat by restricting his output, because wheat is a homogeneous product. Consequently; the price of wheat is often at or below the cost of production. However; a Mazzerati can be sold well above the cost of production by merely limiting the amount of Mazzeratis produced: creating an artificial scarcity. If effective demand is well above the ability of all producers to supply consumer goods, then the price of all goods will eventually rise regardless of the ability to create artificial scarcity. This situation is also known as inflation.
"The essential point to notice, however, is not the profit, but that he cannot and will not produce unless his expenses on the average are not more than covered. These expenses may be of various descriptions, but they can all be resolved ultimately into labour charges of some sort (a fact which incidentally is responsible for the fallacy that labour, by which is meant the labour of the present population of the world, produces all wealth). Consider what this means. All past labour, represented by money charges, goes into cost and so into price. But a great part of the product of his labour -that part which represents consumption and depreciation - has become useless, and disappeared." (C.H. Douglas, "The Control and Distribution of Production")
All costs go into price, and represent the lower limit of price. And all costs can ultimately be resolved into labour charges of some sort. However; the portion of the labour that represents past consumption and depreciation is no longer income. The problem is clear: cost forms the lower limit of price, and all costs go into prices: these prices are paid by incomes, but the portion of cost represented by consumption and depreciation does not exist as income. Therefore, total incomes are less than total costs. If every firm sold their product at cost (i.e. without profit), total incomes would be incapable of purchasing all the products that are produced. This fundamental flaw would have been exposed a long time ago if it were not for an intervening factor - credit from an extraneous source. An obvious extraneous source of credit is consumer credit, which is really a mortgage on future incomes, and only goes to exacerbate the problem as future incomes are decreased by an equivalent amount. However; the gap is mainly hidden by capital production and exportation of product. There are two types of goods: 1) Consumer goods, and 2) Capital goods. Consumer goods are purchased by consumers and their cost is defrayed upon purchase. Capital goods are purchased by businesses in order to produce consumer goods. Capital goods are raw materials, buildings, equipment etc., and their cost is not defrayed upon purchase, but transferred, and the cost ultimately ends up in the cost of a consumer good, where it is eventually defrayed upon purchase by a consumer.
"In consequence, the production which is stimulated - the production which we are asked to increase - is that which is required by the industrial machine, intermediate products or semi-manufactures, not that required by humanity." (C.H. Douglas, "The Control and Distribution of Production")
The cost of capital production showing up in the cost of consumer goods is delayed, because it takes time for a capital good to make its way through productive system in order to be consumed. This fact allows the income from capital production to cover the gap between income and prices on consumer goods. In fact, massive amounts of capital production can lead to inflation in prices of consumer goods, if the effective demand created through capital production is in excess of this gap. Alberta is experiencing this situation currently, as capital production in heavy oil upgraders is dispersing massive amounts of income leading to the inflation of prices - especially for consumer goods whose supply increases slowly (i.e. housing). However; the cost of these capital projects eventually make their way into the cost of a consumer goods (i.e. the cost of the upgraders will eventually be included in the cost of gasoline), and if the money disbursed as income for these capital goods is used on current consumption (which it most likely the case), then it will not be available to meet the price of the consumer good created at a future date. By attempting to close the gap between income and prices of consumer goods through capital production, we are exacerbating the problem, as the gap between income and prices of consumer goods only widens at a future date. When there is a lack of capital production (i.e. investment), firms find their margins decreasing, and we experience a business "slump".
"In other words, it is quite immaterial how many commodities there are in the world, the general public cannot touch them without doing more work and producing more commodities." (C.H. Douglas, "The Control and Distribution of Production")
Regardless of how many consumer goods are in existence, we are unable to purchase them unless we engage in capital production (i.e. there has to be sufficient investment to cover the gap between prices and income), or we engage in a policy of a "favorable balance of trade" (i.e. exports exceed imports) with other nations, disposing of production (i.e. doing more work than is necessary) in order to close the gap between income and prices . The more we engage in capital production, the more we are forced to seek a favorable balance of trade with other nations. This is a vicious cycle, because if we don't engage in excess capital production, or dispose of production by sending it to another country, companies find their margins decreasing, which in turn leads to layoffs, and a recession. However; it is impossible to keep following this path, because increasing investment ultimately leads to inflation as capital production makes its way into the cost of consumer goods, and all industrialized countries are seeking to continuously export their surplus production to foreign nations, which leads to ever increasing third world debt, and friction between industrialized nations, ultimately leading to war. Capitalism is plagued by periods of heavy investment, followed by rising prices, increasing interest rates in order to control prices, decreasing profit margins to businesses, unemployment, and finally a recession. In fact, some people have come to believe that this is a naturally occurring phenomenon like the rising of the sun or the law of gravity: what goes up must come down.
"By an accounting method of analysis, the conclusion is reached that the value, at the current retail price-level, of goods produced far exceeds the flow of purchasing-power from permanent sources. In other words, recurring periods of business depression are shown to be the result of present financial and business policies." (C.H. Douglas, "Social Credit")
Business cycles are simply caused by financial and business policy, and unless there is a change in our policy towards incomes and prices, this will be a recurring problem with our economic system. Attempts to close the gap between income and prices by increasing income through investment simply results in inflation: attempts to close the gap by giving surplus production to foreign nations leads to the struggle for markets, resulting in third world debt, friction between industrialized nations, and ultimately war. Attempts to reduce prices by restricting credit through increasing interest rates is also doomed to failure, because the upper limit of price is governed by the law of supply and demand, but the lower limit is governed by cost of production. It is the rising cost of production that is the primary culprit for inflation, not too much income. If effective demand is insufficient to cover the cost of production, plus the profit margin just large enough to provide incentive to produce, businesses will simply stop producing. This policy leads to bankruptcies and economic hardship.
"Now any attempt, by current financial methods, to reduce prices (or even to stabilise them, as the phrase goes) is a mathematical absurdity unless the cost of this stabilisation, or lowering of prices, is met from some extraneous source. Or to put the matter another way, the margin of profit which makes it possible for a producer to go on producing, disappears unless the financial cost, and consequently the price of production, is allowed to rise steadily in relation to direct labour cost." (C.H. Douglas, "Social Credit")
Central Banks attempts to arrest inflation through the use of interest rates to restrict the supply of money is futile, since it does not deal with the root cause of inflation, making the cure worse than the disease. The artificial restriction of credit causes margins to decrease leading to decreased production, which explains the common fallacy that there is a natural trade-off between inflation and decreased production. In reality, there is no trade-off. Prices can decrease, and production can increase, if part of the cost of production is defrayed with money that did not come from the productive system. Every debt created in the aid of production creates an equivalent cost, because the debt must be repaid. Debt is recovered in prices.
"the consumer cannot possibly obtain the advantage of improved process in the form of correspondingly lower prices, nor can he expect stable prices under stationary processes of production, nor can he obtain any control over the programme of production, unless he is provided with a supply of purchasing-power which is not included in the price of the goods produced. If the producer or distributor sells at a loss, this loss forms such a supply of purchasing-power to the consumer; but if the producer and distributor are not to sell at a loss, this supply of purchasing-power must be derived from some other source. There is only one source from which it can be derived, and that is the same source which enables a bank to lend more money than it originally received. That is to say, the general credit." (C.H. Douglas, "Social Credit")
Mankind will never have control over production, or stable prices, unless we are provided with a steady supply of purchasing power not included in the cost of goods sold. This purchasing power must be created debt free, and given to individuals in such a way that it's not derived from work, for all debt servicing charges, and labour costs, go into the cost of goods sold, and consequently, into price. In this way, improvement in processes, which decrease the real cost of production (i.e. the amount of energy used), will also reduce the financial cost of production, resulting in falling prices. By providing debt free credit to consumers in reduction of prices, and by virtue of a dividend not associated with work, not only will prices fall, but consumers will finally have control over production, and no longer will the productive system have control over mankind.
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