The Diagnosis of Clifford Hugh Douglas
Harold Moulton
[Reprinted from The Formation of Capital,
1935]
Chapter Xl: Conclusions (pp. 155-160)
The foregoing analysis of the process by which capital is created in
the modern world has necessarily been of a somewhat involved character
- tending no doubt toward some confusion as to the precise import of
the conclusions reached. It may be helpful accordingly if the
fundamental elements of the analysis and the primary conclusions be
here restated in as concise and simple form as possible.
At the outset, we called attention to the fact that under any form of
economic organization the formation of capital involves an allocation
of the productive energy of society. Under primitive conditions the
process was a simple matter, involving a direct apportionment by each
individual of his own labor power as between the creation of
consumption goods and capital goods. Under a communistic form of
organization, the allocation of the energy of society is determined by
centralized authority - one portion of the population being set to
work producing consumers' goods and another portion capital goods. In
a capitalistic system, however, the allocation of energy results from
a multitude of individual decisions and is dependent upon the
functioning of a complex financial and business mechanism. The
creation of capital here involves a roundabout process, which,
operating in response to the profit motive, transforms monetary
savings into capital goods.
In neither economic nor business literature is there to be found any
thorough analysis of the economic implications of the process of
capital formation in a capitalistic society. According to the
traditional analysis, the amount of new capital goods that will be
created depends merely upon the proportion of the national money
income that is set aside in the form of savings. When individuals save
money instead of buying consumers' goods, they express a demand for
capital goods; and it is assumed that in response to this demand new
capital goods will shortly be created. To produce such capital goods,
however, it is necessary to shift labor and materials from the
creation of consumption goods, this being accomplished by the
operation of the so called price and profit mechanism. The curtailment
in the demand for consumption goods is matched by an increase in the
demand for capital goods, and the resulting fall in the price of the
former and rise in the price of the latter serve to induce a shifting
of productive energy in response to changing profit opportunities.
In accordance with this analysis all the productive energies of
society are employed regardless of how the total money income may be
apportioned as between consumptive expenditures and savings for
investment. Since all monetary savings are assumed to be transformed
automatically into capital equipment, it follows that the greater the
proportion of the national income that is saved, the greater the
growth of capital and the more rapid the rate of economic progress.
Our analysis of the process of capital formation may be summarized as
follows. To begin with, we challenged the assumption that money
savings enter the market as direct demand for capital goods. We
contended that such savings merely constitute a supply of money
available to business enterprisers for use in the construction of new
plant and equipment. Whether it will be profitable to use such funds
in the formation of new capital depends upon the possibility of
selling the commodities which such capital can produce. The demand for
capital goods is derived from the demand for consumption goods. Hence,
an increase in savings at the expense of consumptive demand will
decrease rather than increase the output of capital goods.
In the light of this general analysis we reached a preliminary
conclusion that if new capital is to be created there must be an
increasing flow of funds through consumption channels as well as
through savings channels. We then turned to a study of the evidence
afforded by our industrial history as to the conditions under which a
growth of capital does in fact take place. The evidence led us to the
following conclusions.
1. The facts show incontrovertibly that new capital is constructed on
an extensive scale when consumption is expanding rather than when it
is contracting. The bulk of our capital is created in periods of
general economic expansion, when productive resources are being more
fully utilized than at other times. The process does not involve an
extensive shifting of labor and materials from consumption goods
industries to the formation of capital. Nor do the prices of
consumption goods and capital goods tend to move in opposite
directions.
2. The evidence indicates that in a period when the output of both
consumption and capital goods is being increased, there is an
expanding flow of funds through both consumption and investment
channels. This simultaneous increase is made possible by the expansive
quality of our commercial banking credit system.
3. The available evidence also supports the view that the growth of
capital is directly related to the demand for consumption goods. In
the first place, changes in the direction of business activity in most
cases appear to have begun with factors affecting the consumption side
of the economic picture. In the second place, the growth of new
capital is adjusted to the rate of expansion of consumptive demand
rather than to the volume of savings available for investment. Between
1923 and 1929, for example, the volume of securities floated for
purposes of constructing plant and equipment remained practically
unchanging in amount from year to year, despite the fact that the
volume of money available for investment purposes was increasing
rapidly. Regardless of the amount of money available for the
construction of new plant and equipment, the growth of capital goods
was adjusted to the rate at which consumptive demand was increasing.
Although the traditional analysis recognized that new capital is
created with a view to a subsequent expansion in the output of
consumption goods, it was assumed that business enterprisers would
proceed for years to create new capital, thereby extending the "roundabout
processes of production," even though consumptive demand might
for the time be declining, or lagging. The facts which we have
assembled afford no support for this assumption.
The conclusions which we have reached with reference to the
dependence of the growth of capital upon the concurrent expansion of
consumptive demand have an important bearing upon the relationship of
the distribution of the national income to economic progress. If, in
consequence of wide variations in the distribution of income, the
proportion of the national income that is saved expands rapidly, there
results a maladjustment which retards rather than promotes the
expansion of capital.
The rapid growth of savings as compared with consumption in the
decade of the twenties resulted in a supply of investment money quite
out of proportion to the volume of securities being floated for
purposes of expanding plant and equipment, while at the same time the
flow of funds through consumptive channels was inadequate to absorb -
at the prices at which goods were offered for sale - the potential
output of our existing productive capacity. The excess savings which
entered the investment market served to inflate the prices of
securities and to produce financial instability. A larger relative
flow of funds through consumptive channels would have led not only to
a larger utilization of existing productive capacity, but also to a
more rapid growth of plant and equipment.
The phenomenon of an excessive supply of funds in the investment
markets had never been anticipated. Not only had it been assumed that
all savings would automatically be transformed into capital equipment,
but it seemed impossible to conceive of a situation in which savings
might become redundant. Such a point of view is natural enough in the
light of our historical evolution.
In the early history of this country the volume of funds available
for the purposes of capitalistic enterprise was persistently
inadequate. Business men often found it difficult to obtain the liquid
capital, at any price, with which to expand the size of their business
undertakings or to exploit new fields of enterprise. In colonial days,
for example, the shortage of funds was a continual source of
difficulty and a primary cause of irritation with the mother country,
which opposed the issuance of bills of credit by colonial governments.
Until well into the nineteenth century the volume of savings rendered
available through investment channels for the needs of business
enterprisers was negligible in amount. The philosophy which emphasized
the fundamental importance of increased savings was a realistic one
for that age.
In the period since the Civil War, however, two factors have combined
to produce a profound change in this situation. The first has been the
growth of a well to do middle class, with funds available for
investment. The second has been the development of the commercial
banking system, making possible an expansion of credit to business
enterprise for both fixed and working capital purposes. It is these
developments which account for the emergence of the United States as a
great financial power. Not only do we now have an abundance of funds
with which to finance American enterprise, but we are also able to
extend credits to the world at large. In this development we have
followed the road which England traveled at an earlier date.
At the present stage in the economic evolution of the United States,
the problem of balance between consumption and saving is thus
essentially different from what it was in earlier times. Instead of a
scarcity of funds for the needs of business enterprise, there tends to
be an excessive supply of available investment money, which is
productive not of new capital goods but of financial maladjustments.
The primary need at this stage in our economic history is a larger
flow of funds through consumptive channels rather than more abundant
savings.
Appendix A: "Other Analyses of Savings Process,"
pp.179-181
No little publicity has been given to an analysis of the sources of
economic difficulty by Major C. H. Douglas of the British Royal Air
Force.[1] Major Douglas finds the roots of the economic disease in the
discrepancy between payments for wages, salaries, and dividends, and
the prices of products. He argues that since the aggregate price of
all goods offered for sale greatly exceeds the aggregate disbursements
to consumers, depression is inescapable unless bank credit is issued
to individuals in sufficient amounts to make up the deficiency in
purchasing power.
Douglas arrives at the conclusion that the money income available for
the purchase of commodities is deficient by a process which eliminates
from the picture a large part of the national income. He contends that
the price of a given commodity must cover "(A) all payments made
to individuals (wages, salaries, and dividends); (B) all payments made
to other organizations (raw materials, bank charges, and other
external costs )."
Now the rate of flow of purchasing power to individuals is
represented by A, but since all payments go into prices, the rate of
flow of prices cannot be less than A + B. The product of any factory
may be considered as something which the public ought to be able to
buy, although in many cases it is an intermediate product of no use to
individuals but only to a subsequent manufacturer; but since A will
not purchase A + B, a proportion of the product at least equivalent to
B must be distributed by a form of purchasing power which is not
comprised in the descriptions grouped under A.[2]
This means that if the payments made by a given business under A
amounted to one dollar and the payments made under B amounted to
another dollar, the price of the commodity produced would be two
dollars; but there would be only the A dollar available with which to
buy it.
The fallacy in Major Douglas' analysis is that he concentrates
attention upon a single business rather than upon the national economy
as a whole. These "external" payments to other organizations
do not involve sending the money outside the country, and hence their
disbursement is a part of the national income as a whole. That is to
say, the payments for raw materials, bank charges, etc., are also
disbursed to individuals by raw material producing industries and "other
organizations" in the form of wages, salaries, and dividends.
Taking the national economy as a whole the aggregate prices of goods
and services simply cover the aggregate disbursements of wages,
salaries, rents, commissions, and profits to individuals engaged in
the processes of production.
The analysis which we have made in
America's Capacity to Consume, revealing a demand for
consumption goods insufficient to call forth the full output of our
productive establishment, is not to be regarded as supporting either
the position of Major Douglas or of Foster and Catchings. Our analysis
did not show that the aggregate disbursements of national income to
individuals were less than the aggregate prices of the goods and
services turned out; on the contrary, we contended that they were
virtually identical. We were concerned with the allocation of the
national income as between savings for investment and expenditures for
consumptive purposes; and we showed merely that the proportion of the
total income received by individuals which found its way into
consumptive channels was inadequate to induce full capacity
production.
REFERENCES
- Credit Power and Democracy, 1920, and The Control
and Distribution of Production, 1922.
- Credit Power and Democracy, pp. 21 22.
SUPPPLEMENTAL COMMENTS Norm Kurland / Center for Economic
and Social Justice / 2005
Dr. Harold Moulton, president of the Brookings Institute during the
Depression, offered the clearest statement (see below) I've seen to
explain why no nation would ever substitute Major Douglas' A+B theorem
for Say's Law. (
The Formation of Capital, 1935.) Kelso's binary economics
leverages Moulton's recognition of the "social nature" of
banking and credit policy to make Say's Law of Markets workable
through universal access to capital ownership and dividend
distributions, without violating property rights of existing owners.
Moulton and Kelso recognized the dangers of printing money that was
not backed by productive assets and Kelso offered a practical solution
to that the problem.
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