For Us, The Living

IX

"Would have come to see you sooner, but the problem presented unusual features that required study." The speaker was a little stoop-shouldered man with a bulging bald head. He addressed Perry over a glass of sherry in the latter's cottage. "When Master Hedrick told me that he wanted me to explain the theory and practice of our present economic system to a man with the point of view of America 1939,Ithought that he was in need of some of his own treatment. But when he elucidated I realized that I was confronted with the most startling problem in pedagogy I had ever undertaken. I wasn't able to undertake it without preparation. I had to search out and read much of the literature of your period and then spend several days in meditation in order to try to feel the period, understand the point of view, evaluations, and the fallacies of your time."

Perry shifted uneasily in his chair. "I didn't intend to cause you so much trouble, Master Davis."

"No trouble at all. You have done me a service. This is a most fascinating approach to the subject that has been my principle interest. By preparing to explain it to you, I understand it better myself. First tell me what you know of the present system."

"Well, in the first place it has retained private enterprise in industry. There I suppose it's a form of capitalism."

Davis nodded. "An inadequate word, but let it stand."

Perry continued, "However, although production, and so forth, is private enterprise, each citizen receives a check for money, or what amounts to the same thing, a credit to each account each month, from the government. He gets this free. The money so received is enough to provide the necessities of life for an adult, or to provide everything that a child needs for its care and development. Everybody gets these checks—man, woman, and child. Nevertheless, practically everyone works pretty regularly and most people have incomes from three or four times to a dozen or more times the income they receive from the government. There is no such thing as unemployment because there is always a demand for more production. Consequently wages are high. However prices are low, and to make the situation even more confusing, merchants regularly sell goods at less than cost, and the government pays them the difference. That is the general set up, if I understand what I have been told. It sounds impossible, an Alice-in-Wonderland business, filled with contradictions that deny common sense. It disturbs me. It challenges my reason. I'd be less annoyed at a perpetual motion machine."

Davis smiled. "I appreciate your difficulty. It is necessary first to clean your mind of a number of the errors, superstitions, and half truths that went by the name of 'economics' in your day. Consider for a moment the physical facts of the situation that you see around you. Disregard the money aspect for a moment and think in terms of goods, people, production and consumption. What then is the situation?"

"Well—I see that everyone has a pretty high standard of living, they live in good houses, and eat plenty of good food, and they have plenty of the comforts of life. That's the consumption side. On the production side I see factories and farms, and so forth, that produce at a high rate with lots of labor saving machinery. Nobody has to work very hard unless he really wants to. Anybody that does gets a big return for it in terms of goods and services."

"Do you see any difficulty in the picture now—still leaving money out of it?"

"Well, no. The physical wealth is there and the work done is enough to turn it into a high standard of living."

"Now describe 1939 in terms of physical economy—again leaving out money. Be careful not to use any term that implies money, such as wages, debt, price, and so forth."

Perry grinned. "You're preparing a trap for me. I can see it coming."

Davis was serious. "It's not a trap. It's a necessary expedient to lead your mind around its ingrown economic errors and enable it to think correctly. Go ahead and describe it."

"Okay. The country was just as rich in natural resources—richer as a matter of fact. We had plenty of factories to fabricate raw materials, but lots of them were shut down. Our farms produced liberally, plenty of good food, enough to feed everybody well. We had the technical knowledge, tools and materials to produce an abundance of luxuries and comforts, and in fact we did, for our retail stores were stocked to the ceilings with every sort of desirable article. That is the production side. On the consumption side about half of the population had less to eat than it needed and that of poor quality and wrong variety. In other respects they were worse off, living in houses that were fire traps, and disease breeders, frequently without running water and with primitive heating systems. Most of them had no medical or dental attention and were rotten with disease. My dentist once told me that four-fifths of the population never received dental care in their lives. The next third or so of the population just barely got by. They lived in fair comfort but in the fear of slipping back into squalor. A small group at the top had more than they needed of everything. While I'm speaking of consumption I suppose I should mention that we made a practice of destroying annually a large part of our production, especially food. Some people considered this wasteful, and we devised means to produce less rather than destroy part of what we had produced. But it came to the same thing."

"You speak of a small group that had too much. Do you know what the result would have been if everybody had consumed share and share alike?"

"As a matter of fact I do. I used to worry about that and worked it out on my slide rule in 1938 from some figures quoted in Time magazine. That was a news sheet published in those days. The average national income came to about one hundred and thirty dollars per month per family, which wouldn't have been a very high standard of living. But the same figures showed that only thirty per cent of the population had that much or more, seventy per cent had less. I have to mention money at this point, but I'll translate it into goods. A family at that standard of living would live in a cheap house, drive a second hand car, set a decent but not fancy table, have a radio, and go to the movies occasionally. But they would have no reserves, and sickness, accident, or the loss of a job would land them almost overnight in squalor."

"Then—still speaking in physical terms—was this average standard of living the best the country was capable of, by and large?"

"Oh no. Not nearly. The country was able to produce at least twice as much as was actually produced. Some authorities said three times or more. But anyone could see by looking around him that much more could have been produced. For one thing at least ten million people were out of work."

"Very well, then. You have described two different economic systems in terms of the physical realities involved. Now which one of them denies common sense, which one challenges your reason?"

Perry smiled. "You've sprung your trap, just as I anticipated. The 1939 system is the ridiculous one, certainly—when you look at it that way. But that still doesn't explain your cock-eyed financial arrangements."

"The paradoxes you appeared to find arise from flaws in your training. They have no reality. I am about to state an axiom: Anything which is physically possible can be made financially possible, if the people of a state desire it."

"That sounds good, but is it true?"

"Yes, if the people of the state understand finance. Tell me, what is money?"

"Money—money is a lot of things. It is a medium of exchange, based on some precious metal, usually gold. It is also a commodity, bought and sold, and rented out for interest. And it's capital for industry."

"Which one of those things is it?"

"Well—when you come right down to it, I guess money is gold."

"That's what J.P. Morgan thought, at least he told a Senate committee that in 1912. I wonder whether he was lying or deluded. Try this definition: 'Money is anything which can always be swapped for goods, or services.' I believe that you will find that to be the only characteristic common to all money, and common to nothing else. How much money does a country need?"

"How can anybody answer that question?"

"Apparently nobody tried to before the present economic regime. Money was expanded and contracted in a most senseless fashion. The panic of 1907 for example was produced by a deliberate contraction of money. But the answer to the question is simple, and arises from the nature or purpose of money as we defined it. A country needs enough money to enable its citizens to perform all desired exchanges of goods and services. Your 1939 system did not accomplish this; our 2086 system does."

"But look—there was plenty of money in 1939. That doesn't make sense."

"Haven't you just told me that in 1939 there were millions of people who needed things they couldn't buy? And weren't there merchants who had all these things and wanted to sell them very badly, yet couldn't sell them? Wouldn't all this have been very different and vastly improved if the people in dire want had had that money in their pockets to buy from the merchants who had to sell or go bankrupt? Isn't that a shortage of money?"

"Yes, of course. But where are you leading me?"

"Patience. In 2086 the government gives money to the people to do that necessary buying."

"Yes, I know. Master Cathcart told me that the government got this money off the printing press or out of the inkwell—in other words fiat money. How can it be worth anything?"

"We decided that money was anything which always could be swapped for goods and services. That implies that the person who accepts it believes that he can do likewise. Therefore money is money as long as everybody believes it is money. There is a touchstone which will enable you to determine whether or not people will believe in money: Can you use it to pay taxes? Will the government give you something for it of value, postal service for example? If the people collectively as a state will accept it, then so will the individuals. Our 'fiat' money qualifies. The United States will accept it in exchange for things of value. That is no longer true of your gold. It can't be used for taxes. You may or may not be able to swap it off, it isn't money, and you may be stuck with it. As a matter of fact all United States currency has been 'fiat' currency ever since the United States suspended gold payments in 1933. Since that time the gold standard has been simply a fiction convenient in party politics. However I believe that your principle difficulty is in understanding why it is necessary for the government to create new money and give it away to the consuming public. In order to understand that, it is first necessary to understand the mathematics of the relationship between prices and purchasing power.

"Before we go into the mathematical theory, let me state the fact which we are to explain: In1939, and before, the sum total of the purchasing power of the public was always less than the total price of the goods offered for sale. This is just another way of saying that 'overproduction', with its attendant unemployment, poverty, labor warfare, and so forth, was a chronic condition. As a matter of fact it is not necessary to understand the mathematics behind it as long as you observe the fact, just as it isn't necessary to know how a house caught fire in order to see that a house is on fire and to realize that something must be done about it. I stated that 'over-production' was chronic and that it is identically the same thing as saying that the public as a whole didn't have the money with which to buy the goods offered for sale. You will certainly agree that such was the condition from 1929 to 1939. It was generally recognized and the government even went so far as to partially make up the spread between prices and income by direct relief—giving money away—and wages for made work—giving money away with a moralistic sugar coating. This would have been sensible had the government created the money by fiat. Instead they borrowed it from the banks who created it by fiat. This was silly as it piled up a national debt to be reckoned with in the future and the money wasn't one whit sounder under the fiat of the banks than it would have been by government fiat. For please understand that the money lent the government by the banks to provide relief did not come into existence until it was borrowed. The bankers took it out of an empty vault—they fished it out of the inkwell. This may be hard to believe but it is the literal truth. Every time a bank loaned money in those days it created it. Of course President Holmes would successfully reclaim this practice for the government decades later, but at this time it was entirely imprudent.

"But to return to 'over-production'. Before 1929 in the period after the World War until the market crash, the spread between production and consumption was absorbed in several ways; an enormous increase in private credit or debt especially in the development of installment buying, exploitation of foreign fields particularly in Central and South America—which means to give away goods and get engraved paper in return, which later turns out to be worthless; and in losses suffered by practically all farmers and many businessmen. You see, a large percentage of businesses failed even in boom times in which case their inventories were sold below cost.

"The condition in the World War years is simple to understand. During war, production goes at maximum speed for the war machine and burns up the excess. Of course an enormous load of debt is created which must someday be cancelled in some fashion. Before the World War there were many years in which the pattern was similar either to the boom twenties or to the depression thirties. In either case production always ran ahead of consumption and was disposed of in the usual ways; by the creation of debt, by destruction of price values through bankruptcy, by sending more goods out of the country than were taken in, or by outright destruction of goods as in war, or, as was done in peace time, by crop destruction.

"The case in which more goods are shipped out each year than are imported deserves special mention. For many years this was regarded as the ideal economic condition although any child can see the absurdity of it, but it was called by all sorts of fancy names; 'Favorable Gold Balance', 'Favorable Trade Balance', 'The American Plan', 'Cornerstone of American Prosperity'. It was taught in the public schools as a natural law."

"Yes," mused Perry, "I remember being taught that in grammar school. My geography book devoted a whole section to telling how necessary it was."

"As a matter of fact it was as vicious as it was silly. Each nation tried to sell more than it bought, and this was the basic cause of every war in modern times. The stupidity of the idea should have been obvious, but the nature of the financing system made it inevitable. Since production always exceeded consumption by a wide margin throughout this period,* [*The reader need not accept this without proof. Fortunately the records of the period are available in the Washington Archives. See statistics of the Department of Commerce, et al., for those years. The Author] it was necessary for a nation to get rid of its excess as best it could or suffer severe economic upset at home. Many were the devices to promote this, for example, the 'protective' tariff and the subsidizing of the merchant marine.

"There was only one period in which this peculiar financial fallacy was suited to the needs of the country, and that was in the days of the frontier. The system created bankruptcy and poverty, and the victims moved west and developed the country. It is customary to speak of population pressure as causing the movement west, but that is true only in a limited sense. The east was never too crowded in the pioneer days to support its population insofar as land and raw materials were concerned, but it already had a financial system which automatically created a spread between purchasing power and production, and thereby automatically created an unemployed class, which moved west with the next wagon train to rehabilitate itself in a simpler economy. Oh yes, we had an unemployed class in Andrew Jackson's day, but we called them pioneers!

"So much for the simple fact that in your 1939 economic system over-production or under-consumption or a shortage of purchasing power was a chronic condition. Now let us examine the mathematical nature of purchasing power to discover why this was so. In so doing we shall discover the possible solutions and select the one we like. You see I've done this problem before and can show off how clever I am. You know about Little Jack Horner? I've always suspected that he knew where the plum was before he stuck in his thumb." A grin split Davis' saturnine visage and made him look like a little bald-headed gnome.

"Consider, if you please, two typical units of production, a factory and a farm. Let the factory be large, an employer with many employees; let the farm be small, a one-family affair. These two cases will be typical—insofar as price and purchasing power are concerned—of the entire economic organism. First, the factory: It makes, let us say, shoes. These shoes are placed on the market at a definite price. This price consists of two parts; the cost to the owner of the factory of making the shoes, plus a profit. The cost consists of a number of items, of which the principle are wages to employees, cost of raw materials, depreciation on capital goods, rent of land, interest on invested capital, and taxes. The additional portion of the price is the profit. This is the return to the owner or entrepreneur for his time, personal labor, ingenuity, and so forth, and is the source from which he must support himself and his family. To assume that profit is unnecessary is to assume that employers don't eat. It was popular in your day to attack the 'profit system'. We shall see that profits to an entrepreneur are not the cause of unemployment and financial distress. Of course there will arise the question of some entrepreneurs receiving a disproportionate amount of production as their profits, but that is a question of morals to be regulated according to the current customs. It does not in itself cause unemployment, as we shall see. As a matter of fact most persons who undertake the enterprise of new production, or entrepreneurs, did not make an excessive profit; most of them made no profit and went bankrupt. That is a simple matter of record. In your day eighteen out of nineteen businessmen failed in the long run. The groups who attacked the 'profit system' were beating a dead dog.

"Nevertheless, since entrepreneurs must eat, profits are a legitimate part of the cost of production. Henceforth we shall include them as cost charges and consider that the necessary value of an article of production is its total cost, or cost to the entrepreneur plus his necessary profit."

Perry interrupted. "Do you mean to say that the profit system in my day was okay? It seems to me that the profit system was always being attacked as the villain in the piece."

"The profit system was not the villain in the piece. The villain was ignorance of the workings of the economic mechanism, in which the entrepreneurs or industrial leaders were the greatest offenders. At the very least the laborers knew that something was wrong and demanded a change, but the industrial entrepreneurs denied that any change was needed, and stubbornly resisted change with the ignorant willfulness of a Marie Antoinette. Furthermore they possessed the economic and political power to resist change. In that way they were the villains and were responsible for all the tragedy of your era. But let's not condemn them too heartily, as they were ignorant and stupid rather than innately vicious.

"But now let's prove the statements I have made. Let's put this factory into operation and see how a cycle of production and consumption works. I mentioned a shoe factory. That will give us too limited a case to understand the whole industrial system. You understand the mathematical principle of the general case, the one in which all possible factors appear. Consequently any individual problem can be solved if you can solve the general case. Of course you do, very well then, let this factory be the general case of any production unit in the country which employs labor and uses capital. Its raw materials will be the materials it processes even though those materials have previously been processed after leaving mother earth. Thus steel plate or tanned leather may be termed raw material for automobiles factories and luggage factories. The term factory includes buildings and chattels of every sort used in production but which are not themselves the goods produced by the factory. Land includes the sites of buildings, rights of way, and so forth. Do you follow me?"

Perry nodded. "Sure. It's like any algebraic general case, like the general quadratic equation for instance; ax squared plus bx plus c equals zero gives a general solution of x equals negative b plus or minus the quantity the square root of b squared minus four ac all divided by 2 a. Substituting the conditions of a particular case gives the answer for that particular case." *

[*ax²+ bx + c=0 x=-b±(√b²-4ac)/2a The full solution of this general problem of the second degree can be found in any textbook of primary algebra. The Author]

"Exactly. Let's set up the general case of a production-consumption cycle under the rules of your period and work out a few problems. Then perhaps we shall see the principles involved and be able to state a general solution which will answer all our questions about economics."

Perry scratched his head. "Look. That's all very well in simple algebra like quadratic equations, but in economics we deal with an indefinite number of unknowns and too many factors. How can we possibly do this?"

"We'll cross that bridge when we come to it. All special cases in the actual world are complex, it is true, even in quadratic equations. But the general case may turn out to have pleasing simplicity. Let's try to formulate it, and see. Have you pen and paper? Let's write down our elements. What are they?"

Perry thought. "A factory."

"Yes."

"The entrepreneur or industrialist."

"Go ahead."

"Raw materials, and labor, and land."

"Continue."

"Consumers."

"That is right, but who are they?"

"Everybody. All of the public."

Davis nodded. "True, but this is the general case. What does that imply?" Perry looked puzzled. "I'll tell you, then. The consumers are the people you mention plus their dependents, and no others. Even retired people enter the picture as capitalists or dependents, as well as consumers."

"Yes, I think I see that."

"Each individual has a dual role, appearing both on the production side and on the consumption side. Even a child appears as a producer through his father and appears as a consumer of goods purchased by his parents. We can disregard dependents from here on as they are represented economically by the head of the family."

"How does a widow living on insurance appear in the set up?"

"As a consumer of earlier production of the deceased head of a family. We'll take that case up later when we are ready to deal with it. Let's get on with our set up. What else do we need?"

"A bank or banks."

"Yes, and bankers, stockholders, bank clerks, and so forth. Will you let me lump them together as a bank and a banker, remembering of course the collective nature of the terms?"

"Okay, I guess."

"Very well, then. Do we need anything else?"

"Not that I can think of."

"Was the United States an anarchy ?"

"No, of course not."

"Then we have the government, and all of the subdivisions of government, public servants, taxes, and laws, and the government as a consumer."

"This grows complicated."

"Not too complicated. Let's represent government, and all subdivisions, as 'US', which you can think of as 'United States' or as 'us', for in the United States the government is everybody taken collectively. Public servants work for 'US'. Now do we have all elements?"

"How about farmers and professional men? They are certainly consumers."

"Yes, that's true. The case of the farmer is simple. Economically speaking, he produces in the same fashion as the factory owner, using the same elements; labor, raw material, land, enterprise, and so forth. If he employs no labor but himself and his family, 'profit' should appear as a large item in cost, and labor wages as zero. It becomes simply a special case under the general case. The professional man appears as a different type of laborer when he is hired by a production unit, for example corporation lawyers. Professional men serving the consuming public directly appear in the production-consumption chain in a one-to-one relationship of transfer without destruction of purchasing power. When you pay a medical man ten dollars for advice, your potential power to purchase and consume doughnuts or automobiles is reduced ten dollars and that of the doctor is increased by ten dollars. There is another element we have not named however. Can you guess it?"

"Mmmmmn—no, I'm afraid not. It seems to me we've covered the—Wait a moment. Technique! Knowledge."

"Exactly. Most knowledge is free to all of us. But some things are patented or copyrighted. Let's call the owners of techniques inventors. Now we are ready to roll. If we set up our hypothetical domestic economy so that it is structurally similar in every way to the economy of your period, it should work like your period. If we change the man-made laws to those of this present period, it will work like this present period. The natural laws involved remain the same structurally. If we can distinguish between man-made rules and natural necessity, we will know what we can and what we can't do with an economic system."

"How can we make any such complicated set up in our heads and be sure that it will work out in practice, Master Davis?"

"I shan't ask you to carry all of the moving elements of a complicated function in your head. Let's make a model. I see a set of chess men over there. May I use them? They will do nicely for people. Now have you anything I can use for counters?" Perry rummaged around and produced a box of poker chips. "Gaming chips? That's fine. Now we need something to represent the goods we are to produce and consume. What do you suggest? I'll need a number of units, a hundred or more."

"How about a box of crackers?" suggested Perry.

"A happy thought. Distinctly consumption goods. But we would get crumbs all over the table and they are rather bulky. Do you have any playing cards?"

"Surely." Perry arose and returned with them. "Here are a couple of packs."

"Very well. Let each card represent one unit of production of equal value. They represent all sorts of items; clothing, food, air cars, games, stereo records, books, and so forth. For convenience we split them up into equal-valued units. Now take the chess men and give them their functions. The black king is our entrepreneur, industrialist, or farmer." Davis wrote this on a slip of paper and tucked it under the base of the black king. "There. We will know him when we see him.

"You will notice that his tag reads 'Entrepreneur-Consumer' to remind us of his dual function. The black queen is his wife. Place her with him. Put a pawn with them as their children. Now another pawn for her father who is dependent on them. He's a crusty old gentleman who hasn't worked since McKinley was shot and thinks the country is going to hell. The white king is the banker. We'll write a tag for him, 'Banker-Consumer'. This box you keep the chess men in will do as a bank, and this book can be a factory. Put tags on them, but don't place the factory on the table yet. It has not yet been built. The black bishop owns the land on which the factory is to rest. He must first be satisfied. The white castle owns a process to be used in our manufacture of playing cards. Now take five or six pawns and mark them 'Laborers-Consumers'. Mark the black horses 'Owners of Raw Materials-Consumers'. Take the white bishops and mark them 'Government Employees-Consumers'. Take a separate tag and mark it 'US' but don't place a chessman on it, as we must not personify the government. 'US' is all of us, acting collectively.*

[*The reader is urged to make this set up and play it through as he reads. Otherwise the value of the demonstration will be lost. If chessmen are not available; bottles of ink, spools, tin soldiers, and so forth, will serve. Beans, dominoes, or marbles will serve as counters. The Author]

"Now we are ready to run through a typical economic cycle. Call it one eon in length and let it be the time from the building of the factory until it is depreciated in value to zero and is obsolete. Something around twenty years if you must think in definite terms, but it isn't necessary to do so. Suppose you identify yourself with the entrepreneur, Perry, and I'll play the other pieces. You see a demand for playing cards and determine to manufacture them. You have your eye on a suitable site which you can lease at a reasonable price, and you know of a new process that you can buy up. But you haven't the working capital, all of your wealth being tied up in tangible property which you don't want to liquidate. So you go to the banker and ask for a loan of a hundred shekels. You explain your idea and offer security worth quite a bit more than a hundred shekels. From where we sit we see that the bank contains only twenty shekels, the capital reserve required by law. One might think that the banker would say, 'Sorry, Old man. You've got a sound proposition and I'd like to accommodate you, but there isn't that much money in the bank.' But he says nothing of the sort; he lends you the money. How does he do it? You give him a promissory note saying:

Dear Banker,

I.O.U. 100 shekels at 10% per eon.

Signed, Entrepreneur

He enters that on the books as a bank asset, credits your account with one hundred shekels, gives you a bank book, and some blank checks, and you thank him for the money, which is new money, monetized by your security and existing only as bookkeeping entries. To symbolize this I hand you these hundred chips, which you must think of as bank credit, or check book money, not as greenbacks, nor metal coin. But you may use them as money in every respect for the banker will cash a few of them from time to time out of the small stock of cash he keeps on hand. He can afford to do this because only on rare occasions will all holders of bank credit ask for cash all at once, placing a run on the bank. Usually cash money paid out by the bank comes back the next day and is re-deposited.

"You have your hundred shekels now and can commence operations. You lease a site for four shekels for the eon. Put four chips by the black bishop. You build your factory, eight shekels for raw materials, eight shekels for labor. Pay out your chips. Now pay the inventor four shekels for the use of his process. Your wages for labor during the eon amount to forty-four shekels. Pay it out. And for raw materials thirty shekels. You will have taxes of ten shekels during the eon."

"I can't pay them. I've only two chips left."

"Never mind. You'll be selling some playing cards soon, and can pay them as you go along. You now manufacture during the eon sixty-three playing cards. Stack them there by the factory. You need eight shekels profit in the course of the eon to support yourself and your family. You figure out what your market price must be for playing cards in order to accomplish this. What would it be?"

Perry set down his expenses and added them up as follows:

Land rent 4 shekels

Factory (labor) 8 shekels

——"—— (material) 8 shekels

Production (labor) 44 shekels

———"———-(material) 30 shekels

Royalty to Inventor 4 shekels

Taxes 10 shekels

Profit 8 shekels

Interest on loan 10 shekels

126 shekels to be recovered as price.

63 produced units to be sold; therefore price must be 2 shekels each.

Perry looked up. "I get two shekels per card."

"Correct. As you can see, I arranged the figures to give round numbers."

"But I can't possibly sell sixty-three cards at that price. There are only ninety-eight shekels out there to buy my product."

"Don't be in a hurry. Start selling and see what happens. We will assume this time that all these people that received money from you need all the consumption goods they can afford. Sell to them."

Perry dealt out cards to 'Labor', 'Land owner', 'Inventor', and 'Owners of raw materials', and collected two chips for each card.

"How many cards do you have left?"

"Fourteen."

"You have a lot of money on hand. Better pay your taxes."

"Okay." Perry placed ten chips on 'US'.

"Now I'll act for Uncle Sam and pay the public servants four shekels, buy raw materials for four shekels, and use two shekels to buy consumption goods from you."

"Here you are." Perry handed Davis a playing card who placed it on 'US' and gave Perry the remaining two chips.

"Now sell goods to 'Public servants' and 'Owners of raw materials'."

Perry did so, handing out four cards and receiving back eight shekels.

"Now pay the interest on your loan. You'll be doing so in the course of the time period."

"Okay, here's ten shekels."

Davis placed them in the bank. "The banker, with his family, clerks, and so forth, needs some consumption goods. Here are two shekels." Perry solemnly received them and proffered one card to Davis.

"Now pay yourself your profit of eight shekels. Turn it over to your wife. She handles the money in your household. She takes it and spends it for consumption goods." Perry took eight shekels, placed it by the black queen, then picked it up again and placed it by the black king, and placed four cards under the black queen. Davis added a comment. "That operation is symbolic of thousands of wives of entrepreneurs spending their husbands incomes on all manners of goods produced in thousands of factories.

"The eon is over. The cycle is finished. Your factory has depreciated to no value at all. I must remind you that your note is due at the bank."

"Wait a minute. Why do you assume that the factory is now worthless?"

"It isn't necessary. Had you figured for a shorter period, the cost item labeled 'Factory' would have been just the percentage of depreciation during the shorter period. There would have been a smaller number of articles manufactured, smaller items in all respects. The final cost per unit would have been the same, but we decided to run through a full cycle, from the beginning to the end of a producing unit. But come, come, you are stalling for time. What about my note? You owe me one hundred shekels."

Perry counted up his chips and grinned at him. "You'll have to whistle for it. I have only ninety-two shekels. I have four playing cards you can have for the balance."

"I've no use for playing cards. I'm a banker and I have your promise to pay."

Perry shrugged his shoulders and did not reply.

Davis continued. "Very well let's get on with the next stage of the game. You have four units of 'over-production' and can't quite pay your note at the bank. But your banker respects your ability. Your original security is still good, and the banker says that conditions are essentially 'sound'. He re-finances you to go into production again. You sign a new note, this time for one hundred and eight shekels and now have one hundred shekels to your account. But your banker cautions you not to be guilty of 'over-production'. You go away, feeling somewhat confused as you don't see where you made your mistake, but the banker must be right for you certainly were left with four playing cards that you could not sell. You decide that the market only requires fifty-nine cards instead of the sixty-three you produced. So you do it all over again, producing only fifty-five cards which with your carry over of four gives you fifty-nine to sell. What is the result?"

"Why, I come out even I suppose."

"Do you? Last time you spent forty-four shekels on wages and thirty shekels on materials to build sixty-three playing cards. How much do you spend this time?"

"Let me see. Forty-four and thirty is seventy-four. The labor and materials cost per unit is one sixty-third of that." Perry set it up on his slide rule. "It comes to one point one one seven five (1.1175) shekels per card. I'm producing fifty-five cards this time. Fifty-five times one point one seven five is sixty-four and seven-tenths shekels."

"Those people bought thirty-seven cards with their seventy-four shekels last time. What can they buy this time?"

"Thirty-two and a fraction."

"Exactly. You sell your best market five fewer cards than last time. As a result of doing the only reasonable thing, you have more cards left over than before, you've thrown some people out of work, you have created less real wealth for the community to use and you are even farther from being able to pay off your note at the bank for you now owe one hundred and eight shekels and have only ninety-one with which to pay."

"Ninety-one? I figured ninety-two."

"No, ninety-one? Perhaps you forgot that your interest is eleven shekels on a hundred and eight."

"That's right. I figured ten, like last time. Now what happens? It looks like I'm going broke."

"Wait a bit. Do you see what caused the original 'overproduction'?"

"Why yes, the banker got money out of me that he didn't turn around and spend with me. Everybody else spent their money as it came in."

"Then what's the trouble?"

"Well, it looks to me as if it was the interest you expected me to pay. If I hadn't had to pay you that interest I'd have come out even."

"Not so fast. They weren't exactly equal and could not therefore have been the same thing. Even bankers have to eat. Why should he run a bank if he isn't paid to do it? Tell me, what would the effect have been if anyone else had saved part of his income instead of spending it?"

"Ohhhoh!" Perry slapped his thigh. "I see! If anyone saves income that he receives from the cycle, it is thrown out of balance and over-production results."

"Exactly. In the problem that we have just gone through I cast the banker as the thrifty villain simply because banks were the worst offenders. They charged as much interest as they could get, and spent very little on consumption, whereas the workers, by and large, had to spend all they got as they went along. But all were guilty of the economic crime of not spending all their purchasing power and thereby saving themselves into bankruptcy, even a father with his life insurance policy and baby with his penny bank."

"Wait a minute, Master Davis. It seems to me that money saved eventually finds its way back into purchasing, even after several years. It all balances out in time. There should have been some consumers spending their savings in that first cycle to make up for those who managed to save."

"There were, of course. If savings are actually tucked away in a sock, it doesn't do much harm. It balances out with just a small carry over of inventories. But most money is not saved that way. Ordinary people invest in life insurance and savings accounts. Industrialists and financiers put it into capital expansion—use it to increase production. In each case it goes into new production."

"But how can that be harmful? We have just shown that money used for production creates new purchasing power to buy the goods produced."

"That's true but you are looking at just one part of the picture. Listen to me carefully. This is the crucial point: Potential purchasing power not spent for consumption but saved and invested for production in a later cycle has appeared as cost in both cycles. When it reappears as purchasing power in the second cycle, it is needed there, and still leaves the first cycle out of balance. For example, if money saved out of your playing card cycle were saved to finance a jelly bean production cycle every shekel of it would appear as cost in the jelly beans and would be needed to purchase jelly beans. It's not available to buy playing cards. To make this exposition rigorous I should mention the possibility that capital funds are occasionally spent on consumption and that money is sometimes taken out of production entirely, but this also produces unemployment and its attendant evils. The Panic of 1907 was of this nature, artificially created by the Morgan Bank and associated interests.

"But let's get back to your playing card factory. It is in trouble. These cycles continue. Each time the bank owns a bigger piece of your business and more of your employees are out of work. Eventually they are in dire distress and private charity cannot carry the load. Congress provides relief. At first Congress tries to pay for relief with new taxes but you business men howl that you are losing money now, which is true. Taxes on everybody—such as the sales tax—rob Peter to pay Paul, and increases purchasing power not a whit. It helps a little to tax the higher bracket incomes but in the long run that inhibits production by striking at a source of capital expansion. Congress is forced to look elsewhere for money to subsidize purchasing power and provide relief, for the spread between production and purchasing power has grown enormous, more than thirty percent in your day, billions of dollars a year. Some congressman from the middle west who cut his teeth on the Bryan campaigns proposes that the government print greenbacks to provide relief for the unemployed, but the bankers condemn this as 'unsound', 'inflationary', 'radical', 'striking at the roots of our institution'. They have great political power and carry their point. There is but one thing left to do and the government does it. It borrows for relief from the banks. True, the banks have very little cash money but the same law that permitted them to lend you money out of the inkwell enables them to lend to the government with the whole United States as security, the security being represented by interest-bearing tax-free bonds. The national debt climbs sky high but the system is held together a few more years, until the banks own practically everything, even the government."

Perry ran his hand through his hair and whistled. "You paint a pretty bleak picture. What is the answer?"

"We undertook to set up a general problem which, when solved, would answer the question in all cases of 'How much money does a country need?' We set up the general production-consumption cycle and worked through some problems under the conditions of your period. We should now be able to work the problem in general terms to arrive at the general answer. I believe you could do it with a little thought, but I will state the general answer for you to inspect and approve or reject. Here it is:

A production cycle creates exactly enough purchasing power for its consumption cycle. If any part of this potential purchasing is not used for consumption but instead is invested in new production, it appears as a cost charge in the new items of production, before it re-appears as new purchasing power. Therefore, it causes a net loss of purchasing power in the earlier cycle. Therefore, an equal amount of new money is required by the country.

"This money must be a new issue, not borrowed from the banks, for there is no way to pay it back. To tax it back from the country as a whole is to destroy necessary purchasing power at a later date. To tax it back from the bondholders is a polite name for cancellation. But that was necessary and was eventually done, in a roundabout manner."

"How?"

"By paying off the bonds with new money, then getting it back with inheritance and income taxes. There are several interesting corollaries to our main proposition. Here is one, 'No economic system can create its own new capital.' That must be done by the fiat of the sovereign state. The banks can't do it, even when they are permitted to create money, as they must recover the money they create and loan, plus a charge for the service, or 'interest'. Furthermore, banks should not be permitted to create money at all, because they are, of necessity, interested only in making a profit. They will inflate or deflate the currency to make a profit regardless of the monetary needs of the country. Their interest rates are a reflection of an artificially created money market with no relation to the cost of the service. No, banks must be required to loan only deposits placed with them for that purpose, that is to say, their reserves must be 100%, not 10% as in your day. They must keep entirely separate the funds left with them for commercial exchange, i.e. commercial checking accounts, funds placed with them to invest orloan, and funds deposited for safe keeping. In such a case the customer pays for the service of checking and exchange, pays for the service of safekeeping, and receives interest on funds deposited for investment. But the banker no longer manipulates the money supply of the nation to suit his convenience.

"Furthermore, from what we defined money to be and from our examination of the production-consumption cycle, we reach the important conclusion that there is no necessary one-to-one relationship between taxes and government expenditure. If a country is expanding industrially as the United States has since it was founded, the government is obliged to put out more money than it receives in amount equal to new capital investment in order to avoid deflation. This is new money never received in taxes. In fact the Federal government need not tax at all, except as a regulatory measure. It needs no taxes for revenue. It must never tax as much as it spends or gives away, as long as production is rising. This gives the government remarkable freedom. If a new battleship or a new highway was needed in your day, the economically sound thing to do would have been to go ahead and build, paying for it with new currency. Congress should consider only two things: 'Does the country need this battleship, or road.' And 'Is the country rich enough in manpower and materials to produce it?' If both answers are yes, go ahead and issue new money to do it."

"Just a moment, Master Davis. What is this new money worth, if anything?"

"How do you mean that?"

"Well, in my day money could be exchanged for gold, not very easily, but it could be done. How can one be sure that this new money is anything but pieces of paper?"

"As I told you before, the government will accept it for taxes, and for services such as the postal service. But you want to know what it is worth in terms of real wealth, just as the old style dollar was worth so many grains of gold. Very well. If you present a draft for a thousand credit units or dollar bills to any one of several government warehouses, the bursar will give you an assorted group of basic commodities of weights and standards specified by law."

"Where does the government get these commodities?"

"Grows or makes them, buys them in the open market, and may occasionally accept some of them as taxes."

"That seems awfully cumbersome compared with the gold standard."

"It is cumbersome, but it's worthwhile for it gives a much more nearly stable medium of exchange than gold. As a matter of practice the government keeps very small stocks of commodities because with a stable standard for money the public prefers cash or credit at the Bank of the United States to the trouble of handling bulk in commodities. They are satisfied to know that they can get real wealth in specified amounts, if they choose."

"How about foreign trade? This sort of money would be a nuisance there."

"Gold, as well as platinum, silver, and other convenient commodities, is still used in foreign trade exchange. The government buys and sells these commodities in the open market as a convenience to its citizens."

"I guess that clears it up. It still seems complicated."

"It is, Perry, more or less. But it isn't anything to the anarchistic maze that your old money system was. Let's get back the tax problem. The fact that there is no necessary one-to-one relationship between taxes and government expenditure is startling at first, but is evident from the nature of money. Money in the hands of an individual is a token of a debt to one of us owed by all of us. This token in the hands of the government states that all of us, i.e. the government, owe a debt to all of us, i.e. the government—an absurdity. One cannot owe oneself a debt in any but a poetical sense. Money in the hands of the Federal government is a scrap of paper and ink. It is significant only when held by individuals or groups of individuals.

"We recognize nowadays that Federal taxation is a deflating process, and that Federal government spending is an inflating process. Each process has important secondary effects through which it can be used to regulate for the general welfare. Taxation may be used to prevent unwholesome concentration of wealth. It may also be used to prevent too great a difference in the net income of individuals. The issue of new money is an even more powerful instrument in shaping our economic life to suit our wishes. It is a means of ensuring social security for the entire population through the dividend or inheritance checks. It can stimulate production and prevent inflation of prices through the use of the discount. It is used to assure an equal start for every child. In fact the knowledge of how to use money enables us to inhibit or encourage almost anything without coercion. If we desired, we could institute as near complete a socialism in the United States as we wished, without confiscation and taking over the tools of production. The present set up suits us now. We can change it if we like, when we like, for we understand the economic mechanism. The economic determinism of Marx is an exploded bugaboo, and the American people are the masters, not the slaves, of their economic system."

Davis took a sip of sherry, and looked slightly giddy. "You'll forgive my enthusiasm, I trust. This is my subject and I am sometimes carried away by it."

"I am not surprised," replied Perry. "You have reason. I confess I don't see all those implications just yet, but it sounds amazing."

"You will see," returned Davis, "and by the very method we used. You can set up this game with the chessmen to cover every possible case. For example, throw in some professional men and observe that the cycle is unchanged. Provide a foreign trade with a balance in our favor and see how the cycle can be made to balance. Then a foreign trade in which goods are dumped on us and see how it dislocates our system. Then change the supply to balance it anyhow and observe how we can benefit. Play two tables and let trade flow between the tables. Set up a farm production cycle on one and factory on the other. Throw in corporate organization, trust funds, re-discounted paper, and so forth. Have a labor leader organize the workers and stage a strike. Get a lot of bank credit passed around and then make a run on the bank. Issue stock and watch it fluctuate in market price. Declare war and put industry on a war basis. Inflate the currency. Deflate it. Save your profits to expand your business. Cut prices to meet competition. Get squeezed on your lease. Start out from primitive barter, work up the present system with the dividend, the discount, and the National Account. Do all of those things, but be sure to observe the rule of duplicating the structure of the real world. It's fascinating and you will teach yourself more about money and economics than anyone else can possibly teach you. Bear in mind the fundamental theorem that we formulated about the necessity for new money for capital expansion. If you find any situation which appears to contradict it, or any of our other conclusions, go back and do it over, writing down each step in detail. If you don't find your error, give me a call. But I'm sure you will.*

[*Several typical problems have been worked out for the benefit of the reader and appear as an appendix at the end of the book. A typical modern cycle is given showing the dividend and discount in operation. Especially interesting are examples of twentieth century economics showing the ridiculous impasses into which our forefathers fell simply through failure to understand the nature of money. The Author]