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The Unfeasibility Of The Social Credit Solution
By Gabriel Martinez
Rebuttal Remarks By Dick Eastman
I thoroughly share Oliver Heydorn's concern for the way in which the debt-finance system oppresses many. Indeed, my research has been on how the irresponsible use of debt created economic chaos in Ecuador. Nevertheless, I think that three main points of criticism can be pointed out from an economist's perspective: on the nature of fractional reserve banking, on the sufficiency of money supply relative to output, and on Social Credit itself.
First criticism:
Martinez: First, Mr. Heydorn rightly points out that the banking system creates money by the process of lending. This is the process: Smith takes his $100 to a bank. The bank lends $90 of it out to Jones. Jones takes the $90 and with it he opens a new bank account. Result: you have a total of $190. And so on.
Dick Eastman reply: Smith takes $100 dollars from his mattress or from sale of a bond to the Fed and deposits it. But that bank won't have the deposit for long as Smith will be spending it soon. But no matter, the check will be in some checking account at all times until someone withdraws the 100 and puts it once more in a mattress. However the banking system will have the 100 added to reserves upon which 90 can be loaned -- a new deposit, against which 90 percent can be loaned by the system -- which will again be spent but will raise the reserve level of the system by 90 and so on. Yes, that is how fractional banking - and the money multiplier works.
Martinez: Out of this $190, the original $100 in cash is "true" paper money while the $90 is just credit money.
Dick Eastman reply: No the $100 does not have to be a Fed reserve note. The Fed can just credit an account upon the sale of a bond to the Fed by Smith.
Martinez: Can a bank charge interest on credit money? Mr. Heydorn argues that it can't, because credit money is created ex nihilo, without any cost.
Dick Eastman reply: All money is credit money and interest is charged on it. Mr. Heydorn sounds like a gold-standard libertarian.
Martinez: "The problem with the fractional reserve system is that although it cost the financiers little or nothing to create this new money, they nevertheless insist on interest payments.... [T]he loan is not the product of a cost-generating process."
Dick Eastman reply: No the problem of the fractional reserve system is over-indebtedness and chronic deflation because the financial sector is lending this new money but all of that money must be paid back plus interest -- the end result must be deflation.
Martinez: We can infer that Mr. Heydorn has never worked at a bank. Indeed, we ought to infer that he has never applied for a car loan or a mortgage. Anyone who has experienced the loan process (on either side) can testify that considerable work and effort goes into making a loan (from identifying a suitable loan candidate, to presenting attractive offices, to persecuting delinquent debtors, etc.)
Dick Eastman reply: This is usually true about loans -- but the problem is that even good loans to a well qualified borrower become bad loans under deflation and when in response to deflation the banks liquidate loans because of non-payment and pessimism due to the deflation caused recession.
Martinez: Moreover, loans are not created ex nihilo. Consider what would happen if Smith withdrew his $100 from the bank. The bank would be forced to call in Jones's $90 loan. That is, banks need deposits to make loans.
Dick Eastman reply: The fact that calls on loans operate the money multiplier in reverse -- monetary contraction and deflation -- does not change the fact that the money multiplier that works because of fractional reserve banking is indeed money created "out of nothing" - a multiple of the original deposit.
Martinez: Bank employees can testify to the enormous effort that goes into getting people to trust a bank with their money. If Jones gets $90, it is only because Murphy spent endless hours making the bank attractive to depositors (which, incidentally, includes persecuting delinquent debtors.)
Dick Eastman reply: You mean charging a woman $35 for each of five NSF checks because she ran out of diapers before pay day and wrote a check for some -- and the bank cashes the biggest checks first so there will be a lot of little checks going NSF rather than processing the big check last so that only one check goes NSF. Yes this is a lot of work for the poor banker -- but it is not work "creating money" -- the money is still created by the banking system at no cost.
Martinez: People are often happy to receive loans. For instance, students are very happy not to have to pay college tuition right away; they can cover their tuition with loans. Where does that money come from? It comes from the effort of the bank employee and the trust of the depositor. I believe that that effort (and risk-taking) and that trust deserve compensation.
Dick Eastman reply: That's it? Where is the argument against social credit? Is this man so stupid? Does he think his students are that stupid? The argument is empty nonsense.
Second criticism:
Martinez: "Whenever a banker creates a loan and demands to be paid back with interest, he only introduces the principal into the monetary supply; he does not introduce any money to cover the interest payments which may, in the long run, amount to more than the principal itself. The result is that under the current financial set-up there is a chronic lack of money that artificially limits both production and consumption."
Dick Eastman reply: Now Heydorn is making sense. Let's see what Martinez says.
Martinez: If this were true, then countries with extensive financial systems would be chronically poor and financially strangled, while countries with not much banking would be models of stability and prosperity. The evidence proves the opposite.
Dick Eastman reply: More precisely those countries with a lot of debt outstanding would tend household and business sector poverty because of deflation. The deflation would lead to businss loss and bankruptcy and foreclosure on homes -- the assets - collateral -- would go to the creditors, and the borrowers would lose everything. After liquidation (transfer of all collateral to the lenders) then new loans will again be made. The new loans are stimulus until the interest payments and principal payment as leakages begins to overwhelm the stimulus as injection. Deflation is back, and once again the financial sector gets the factory and homes (which become rental properties) in which the financiers had no hand in building.
Martinez: The reason that Mr. Heydorn's argument seems plausible is that we are used to thinking of an economy in fixed, static terms. But the economy is dynamic. Loans are used to finance productive investment, which in turn increases output.
Dick Eastman reply: No, actually the above socialc credit analysis is the dynamic one -- there is no equilibrium -- the tendency is always towards deflation, which is only countered by new big borrowing, which only sets up bigger interest payments and more loan principal to retire - leakages again after an interval overpowering injections -- until a war or a bailout that is debt financed buys another short period of being ahead of deflation -- but deflation is never really escaped, just postponed for a while.
Martinez: The profits of successful investment pay for the interest and the principal.
Dick Eastman reply: Actually no. Profits do not grow like compound interest. A new machine starts to ware out the minute it is completed. Or its function is no longer in demand. The compound interest grows indefinitely and geometrically. But we see that there is chronic deflation - so the consumers cannot buy what is produced -- profitability and success does not happen -- without the fix of an emergency stimulus (like war expenditure) which is debt financed. If it were not for the drain of interest as well as of principal, there would be enough money for producers to sell their wares tot he domestic economy -- the payments to factors would be enough to pay the costs of production that go into the price of the finished product. But not so when selling price must also include payments for financing.
Martinez: Central Banks, in turn, are permanently in the business of making sure that they print enough bills (which get multiplied by the fractional reserve system) to match the growth of the economy. (Technically, central banks set money-supply growth on the basis the predicted output growth).
Dick Eastman reply: While they may put more cash in the system at Christmas time -- generally there is a chronic shortage of purchasing power which is causing the bankrupticies and unemployment. There is no way that there is enough purchasing power so that household demand can pull the economy up. That is why social credit is necessary. This notion that the Fed predicts economic growth and then matches the money supply to meet the need is the biggest fantasy and joke yet. It is the chronic lack of purchsing power that is sought by the Fed, -- because deflation means the value of bond portfolios increases. Deflation means debt burden grows. In the great depression lots of debt was liquidated, but because of drastic deflation the purchasing power of each dollar that must be paid back grew so much that the real burden of debt actually increased -- the liquidation failed to liquidate. Martinis is a public relations man who -- to keep a job in this economy -- is willing to tell people any lie -- even lies he cannot get away with like the banks providing money supply according to needs. Remember - when there is deflation those holding bond wealth become richer. Those who are debtors must repay in dollars worth more than the dollars they originally borrowed -- the debtor has to work harder to get those dollars than the dollars that were originally borrowed -- due to deflation.
Third criticism:
Martinez: "Instead, a National Credit Office would be charged with the responsibility of ensuring that the money supply is always equal to the productive capacity of the economy, in such a way that purchasing power is sufficient to liquidate supply.
[We've already argued that Central Banks regularly do this]
Dick Eastman reply: You argued all right, but you didn't demonstrate or prove. In fact you are wrong. When there is a shortage of purchasing power and the result is deflation and recession -- the banks do not replenish purchasing power among the household and business sectors -- they put out a flow of loans injected intothe economy but over time they have taken out of circulation principal equal to those loans plus interest. The system leads to deflation, defalut and a transfer of real assets from debtors to creditors -- creditors who made loans that were backed by the borrowers collateral and which cost the bank next to nothing to provide.
Martinez: quoting H: "[This money] would be introduced into the economy debt and interest free. Some of this new money would be used to finance government expenditure on health, education, infrastructure, defense and so on (thus eliminating the need for taxes); some of it would be distributed to each citizen in the form of a social dividend that would guarantee everyone a minimal revenue (thus eliminating destitution and the more severe forms of poverty); and some of it would be used to finance the retail sector while lowering the prices of goods and services for consumers (thus allowing for the recalibration of the whole system and the prevention of inflation.)"
Dick Eastman reply: Yes, the above paragraph describes some fo the benefit of switching to the social credit system.
Martinez: This sounds very nice, but it is based on an equivocation. Money is not wealth, at least not how economists define it. When I say, "Sally has a lot of money," I may mean lots of real estate, yachts, stock holdings, or cash. But when an economist says, "Sally has a lot of money," he only means cash or deposits.
Dick Eastman reply: Money is an asset, and a highly speculative one these days. It is held for a variety of reasons. However real wealth is a bond, because bonds pay interest -- it earns.
Martinez: Now, let's say that Mr. Heydorn (and his source, Scottish engineer C.H. Douglas) are thinking of distributing wealth for free. We have such a system in place already, in the form of unemployment benefits and farm subsidies. But to actually plan to sustain the entire economy on the basis of freely (and centrally) produced wealth implies that goods and services can be produced without cost. Reminder: There ain't no such thing as a free lunch. It also implies the elimination of personal responsibility and the collectivization of economic initiative. Not very distributist-sounding.
Dick Eastman reply: Actually, the finacial sector has imposed deflation (though calling loans to liquidate debt outstanding) which causes sound businesses to become unsound. A few bankers have the power to stop the entire economy. Martinez doesn't realize that there are plenty of people willing to work and plenty of resources for production and plenty of entrepreneurs and engineers to get the work done in a cost effective way -- but what is lacking, what is causing recession is the financial sector -- the scarcity of M1 money. And yes, the creditors are getting a free lunch by this deflation. The interest dollars they are collecting are worth more than the dollars they loaned to the borrower originally.
Martinez: Maybe Messrs. Heydorn and Douglas actually meant distributing money for free. Let's think technically for a bit. Prices are proportional to the ratio of the available money (cash and deposits) divided by the amount of goods and services available. This will become clear if we think that money is used to buy goods and services. Then, if there is more money (cash and deposits), that ratio has to rise: i.e., prices will have to rise.
Dick Eastman reply: Martinez is arguing that if the society makes an economic pie and pays dollars to those who baked it which dollars can be spent in buying the pie -- then the dollars spent will be enough to buy all the pie. However if the bakery and ingredients required a business loan then not only must the loand be paid back, but the interest on the loan as well. That interest will be money that will not be going to buy pie. Thre will be unsold pie -- unless the price per slice goes up or else the size of a slice of pie a dollar will buy goes down. Unsold inventories will mean layoffs in pie production. Less pie. Falling standard of living. Martinez believes in the naive Say's law -- but supply does not call forth its own demand under usury -- because interest is withheld and not spent on pie. The recession means that investment in new production will not be profitable and will not happen. The interest earnings of the financial sector are not invested in a recessionary/ deflationary market environment -- just as tax cuts for the rich are not invested. The only way to end this problem is with social credit putting spending power free and clear into the hands of households. Let the household sector be the only source of new money.
Martinez: Imagine financing the government, the citizen, and the retail sector (which is not formed by citizens, I assume) by constant costless, unbacked money creation: the result is economic chaos.
Dick Eastman reply: Backing does nothing but inflict a new cost. Gold backing is merely an engine for deflation. Gold serves the debt slavery system. Credit expansion and contraction are both possible and are both historical problems under the gold system. Having ample purchasing power to keep businesses going and to prevent houses from being forclosed -- is not wasted money -- it is in fact the best that one can do to strengthen the household and business sectors which have been robbed blind by deflationary recessions leading to the elite buying up the all in distressed seller sales.
Martinez: Indeed, this is the experience of many countries that tried to finance government expenditures by monetary creation: Germany, Hungary, Argentina, Brazil, Ecuador... the list goes on. Rapid monetary creation leads to inflation, which (by a familiar economic process, known as the Oliviera-Tanzi effect) leads to reduced government revenues, a higher deficit, and a need for more money cre-ation...
Dick Eastman reply: Actually these hyperinflations were caused by central banks deliberately stealing the savings of the middle class. Once the savings of the middle class are diluted out of existence -- Germany in 1923 or the US in 1979 then the money power switches to tight money policy -- as the printing press gives money to the friends of the financiers. But this is not social credit. These hyperinflations occured under gold standards and by people opposed to the social credit type reforms that would have made such theft (of savings) by inflation followed by theft (of earnings) by deflation tht requires the borrower to work harder for each dollar he must pay in interest and principal to the lender.
Hyperinflaiton never happens without the explicit concent and effecting hand of the banking system. It is always a deliberate policy to degrade the middle class in advance of a monetary contraction in which all assets devolve into the possession fo the creditors.
Martinez: Often "hyperinflation" leads to massive social and economic disruption. Think of Nazi Germany following the German hyperinflation; think of Ecuador having to abolish its national currency and replace it with trustworthy, and scarce, American dollars.
Dick Eastman reply: But Germany did nto have socialc credit. Their money supply was in the hands of financiers -- especially the victors of WWI.
Martinez: In closing, a quote from well-known economist J.K. Galbraith is appropriate:
"Over all history, money has oppressed people in one of two ways: either it has been abundant and very unreliable, or reliable and very scarce." n
Dick Eastman reply: Social Credit is the exception, when it is tried.
The financiers have made deliberate recessions by contracting the money supply -- by doing the opposite of what social credit does. 1836, 1893, 1929 and the first decade of the 21st century were man made crashes and depressions. Only social credit takes the power of making new money and destroying money out of the hands of hostile international finance.
Dr. Martinez teaches economics at AMC.
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