The Nature of Environmentalism

In my previous post, “A Word to Environmentalists,” I wrote "the first step you need to take is to stop using the same word `environmentalist’ to describe both them [advocates of mass destruction and death] and you. So long as you do use the same word, people cannot help but think of you all in the same terms.”

In reply, a respected colleague of mine at the Mises Summer University, wrote the following:

I'm not sure I buy that argument. It seems to assume something like the following premise: “If many of the most prominent people who embrace the label `X-ist’ have advocated bad stuff, then one shouldn't call oneself an `X-ist.'” But that premise seems to have some odd con-sequences, as follows:

Many of the most prominent people who embrace the label "atheist” (e.g. Stalin, Pol Pot) have perpetrated great evil, so Ayn Rand shouldn't have called herself an atheist.

Many of the most prominent people who embrace the label “liberal” (e.g. Woodrow Wilson, FDR) have perpetrated great evil, so Ludwig von Mises shouldn't have called himself a liberal.

Many of the most prominent people who embrace the label “capitalist” or '”free-marketer” (e.g. the GOP) have perpetrated great evil, so George Reisman shouldn't call himself a capitalist or a free-marketer.

Many of the most prominent people who embrace the label "egoist” (e.g. Max Stirner, Nikolai Chernyshevsky), while not exactly perpetrators of evil, have at any rate advocated some pretty dubious stuff, so Ayn Rand shouldn't have called herself an egoist.

And so on.

I mean, why let the bad guys set the meanings of all these terms?

I have quoted my colleague not so much in order to answer him in particular, but because his response provides a good starting point for providing a further explanation of the profound and inherent evil of environmentalism and why a reasonable person should no more call himself an environmentalist than he would call himself a Communist or Nazi.

It should be realized first of all that “environmentalism” is in a very different category than the examples of the advocacy of atheism, liberalism, et al. by authors who also propound clearly destructive ideas. This is because atheism, liberalism et al. in themselves do not represent a philosophy or program that is evil on its face or that necessarily implies evil. (In this connection, it should be recalled that Stalin and Pol Pot committed their atrocities not in the name of atheism, but in the name of Communism.) In addition, in all of the examples cited there are also prominent supporters of the doctrines who go out of their way to present theories and programs that demonstrably promote human life and well being. Thus both Ayn Rand and Mises were atheists, liberals, pro-capitalist and pro-free market, and were egoists. Their writings serve as far more than a counterweight to the wrong or dubious ideas of other supporters of these doctrines and, indeed, make a compelling case for why these doctrines themselves in fact serve to promote human life and well being.

However, there are no counterparts to Rand and Mises in the advocacy of environmentalism. (Nor could there be.) No one in environmentalism rises to challenge the evils that its leaders and spokesmen advocate or to show that environmentalism is the opposite of what they claim.

By way of contrast, consider the following case. Imagine that someone known as a prominent supporter of Austrian economics wrote an article or gave a speech in which he advocated the enactment of wage and price controls or the nationalization of industry. I think that everyone affiliated with the Mises Institute, certainly myself included, would be all over this person and make it as clear to the world as possible that his views not only did not represent those of Austrian economics but were in complete and total opposition to everything Austrian economics stands for.

Now imagine that a prominent environmentalist writes an article or gives a speech in which he expresses the wish for a virus to come along and wipe out a billion people. What will be the reaction of the environmental movement? Will that individual be denounced for misrepresenting the movement? Will the rest of the movement’s leaders rush to assure the world that that individual was so far from representing environmentalism that he actually represented the diametric opposite of its principles?

Not at all. There will be no negative reaction of any kind from within the movement, not even a raising of eyebrows. I can say this with the utmost confidence, because such statements have already been made, and made repeatedly. And there has been no outrage, no negative response of any kind from within the environmental movement.

Here’s David M. Graber, in his prominently featured Los Angeles Times book review of Bill McKibben’s The End of Nature: “McKibben is a biocentrist, and so am I. We are not interested in the utility of a particular species or free-flowing river, or ecosystem, to mankind. They have intrinsic value, more value—to me—than another human body, or a billion of them.… It is cosmically unlikely that the developed world will choose to end its orgy of fossil-energy consumption, and the Third World its suicidal consumption of landscape. Until such time as Homo sapiens should decide to rejoin nature, some of us can only hope for the right virus to come along.”

And here’s Prince Philip of England (who for sixteen years was president of the World Wildlife Fund): “In the event that I am reincarnated, I would like to return as a deadly virus, in order to contribute something to solve overpopulation.” (A lengthy compilation of such statements, and worse, by prominent environmentalists can be found at Frightening Quotes from Environmentalists.)

There is no negative reaction from the environmental movement because what such statements express is nothing other than the actual philosophy of the movement. This is what the movement believes in. It’s what it agrees with. It’s what it desires. Environmentalists are no more prepared to attack the advocacy of mass destruction and death than Austrian economists are prepared to attack the advocacy of laissez-faire capitalism and economic progress. Mass destruction and death is the goal of environmentalists, just as laissez-faire capitalism and economic progress is the goal of Austrian economists.

And this is why I call environmentalism evil. It’s evil to the core. In the environmental movement, contemplating the mass death of people in general is no more shocking than it was in the Communist and Nazi movements to contemplate the mass death of capitalists or Jews in particular. All three are philosophies of death. The only difference is that environmentalism aims at death on a much larger scale.

Despite still being far from possessing full power in any country, the environmentalists are already responsible for approximately 96 million deaths from malaria across the world. These deaths are the result of the environmentalist-led ban on the use of DDT, which could easily have prevented them and, before its ban, was on the verge of wiping out malaria. The environmentalists brought about the ban because they deemed the survival of a species of vultures, to whom DDT was apparently poisonous, more important than the lives of millions of human beings.

The deaths that have already been caused by environmentalism approximate the combined number of deaths caused by the Nazis and Communists.

If and when the environmentalists take full power, and begin imposing and then progressively increasing the severity of such things as carbon taxes and carbon caps, in order to reach their goal of reducing carbon dioxide emissions by 90 percent, the number of deaths that will result will rise into the billions, which is in accord with the movement’s openly professed agenda of large-scale depopulation. (The policy will have little or no effect on global mean temperatures, the reduction of which is the rationalization for its adoption, but it will have a great effect on the size of human population.)

It is not at all accidental that environmentalism is evil and that its leading spokesmen hold or sanction ideas that are indistinguishable from those of sociopaths. Its evil springs from a fundamental philosophical doctrine that lies at the very core and deepest foundations of the movement, a doctrine that directly implies the movement’s destructiveness and hatred of the human race. This is the doctrine of the alleged intrinsic value of nature, i.e., that nature is valuable in and of itself, apart from all connection to human life and well being. This doctrine is accepted by the movement without any internal challenge, and, indeed, is the very basis of environmentalism’s existence.

As I wrote in Capitalism, “The idea of nature’s intrinsic value inexorably implies a desire to destroy man and his works because it implies a perception of man as the systematic destroyer of the good, and thus as the systematic doer of evil. Just as man perceives coyotes, wolves, and rattlesnakes as evil because they regularly destroy the cattle and sheep he values as sources of food and clothing, so on the premise of nature’s intrinsic value, the environmentalists view man as evil, because, in the pursuit of his well-being, man systematically destroys the wildlife, jungles, and rock formations that the environmentalists hold to be intrinsically valuable. Indeed, from the perspective of such alleged intrinsic values of nature, the degree of man’s alleged destructiveness and evil is directly in proportion to his loyalty to his essential nature. Man is the rational being. It is his application of his reason in the form of science, technology, and an industrial civilization that enables him to act on nature on the enormous scale on which he now does. Thus, it is his possession and use of reason—manifested in his technology and industry—for which he is hated.”

Thus these are the reasons that I think it is necessary for people never to describe themselves as environmentalists, that to do is comparable to describing oneself as a Communist or Nazi. Doing so marks one as a hater and enemy of the human race.

Whoever believes that it is possible to be a “free-market environmentalist” is guilty of a contradiction in terms. The free market rests on a foundation of human life and well-being as the standard of value. Environmentalism rests on a foundation of the non-human as the standard of value. The two cannot be reconciled. It’s either-or.

I know that these conclusions are upsetting to many people. It’s got to be upsetting to realize that one is advocating destruction and death. But fortunately, there’s a simple and ultimately happy solution: just stop doing it. Stop being an environmentalist!

Copyright © 2008, by George Reisman. George Reisman, Ph.D. is the author of Capitalism: A Treatise on Economics (Ottawa, Illinois: Jameson Books, 1996) and is Pepperdine University Professor Emeritus of Economics. His web site is www.capitalism.net.

A Word to Environmentalists

The “extremists” among you openly call for the death of 1 to 6.4 billion human beings. The “moderates” among you openly call for the forced reduction in carbon dioxide emissions of 90 percent within a few decades, which would serve to reduce energy use almost to the same extent. Such a severe reduction in energy use follows from the fact that there are no presently existing large-scale viable alternatives to fossil fuels other than atomic power, which is regarded by most members of your movement as a death ray and is opposed more vehemently than fossil fuels. Furthermore, the likelihood of ever finding and developing such alternatives will be greatly reduced by destroying the energy sources we do have and need to increase. So what your movement advocates is mass death or, at the very least, dreadful mass impoverishment whose outcome will be tens or hundreds of millions of unnecessary deaths and a life of misery for those who survive.

If your motivation in calling yourself an environmentalist is merely such things as that you like to see flowers bloom on open meadows, and love trees, whales, and polar bears, and the like, then you owe it to yourself to put as much intellectual and moral distance as possible between you and those who advocate mass impoverishment and mass death.

The first step you need to take is to stop using the same word “environmentalist” to describe both them and you. So long as you do use the same word, people cannot help but think of you all in the same terms.

Don’t think you can solve the problem by calling yourself a “free-market environmentalist.” That’s like calling yourself a “free-market Communist” or a “free-market Nazi.” They’re contradictions in terms.

The free market exists to promote prosperity and human life, and that is what it has accomplished, splendidly, with breathtaking brilliance. In the industrialized world, the average person today enjoys a standard of living superior to that of kings and emperors of the past. The whole world’s population is capable of enjoying the same marvelous results, if it adopts economic freedom. But if you call yourself an “environmentalist,” you mark yourself as sharing the goals of mass destruction and death. A socialist dictatorship is the vehicle for achieving those goals, not a free market.

It is true that many American businessmen, some of them extremely talented and successful, now call themselves “environmentalists” and are stumbling over themselves in a race to prove how “green” they are. In the early 1930s, many talented and successful German businessmen did essentially the same thing when they began to call themselves “Nazis” and raced to prove their devotion to National Socialism. It’s possible for people to be geniuses in one area of their lives and fools, or worse, in other areas. In any event, the outcome for the German businessmen, and for all other talented individuals who joined either the Nazis or the Communists, was that they ended up as accomplices of mass murderers. The same will be true in the United States, if the environmentalists succeed in imposing their agenda.

If you care about your moral character, don’t place an indelible stain on it by supporting a movement that seeks to destroy Industrial Civilization and all the human lives and human well-being that depend on it. Accept moral responsibility for the ideas you propound and stop standing in the service of mass destruction and death.

Do not come back with the argument that if we uphold individual freedom, our great grandchildren will have to live in an uninhabitable planet, one that is either too hot or too cold. Sooner or later Nature itself will make the climate considerably warmer or considerably colder than it is today (most likely colder). The only significant question is what is the best method of coping with such change? Is it the free market or a centrally planned dictatorship that reaches down into every detail of everyone’s personal life and productive activities, that, indeed, wants to control the carbon content practically of every breath that anyone draws?

Even if you are absolutely convinced that human activities are responsible for global warming and, if nothing is done, will ultimately result in an intolerable rise in temperature, there is a very simple test that you need to apply. Pretend, for just a moment, that that same global warming is coming about independently of human activities, that it is strictly the product of natural forces. Then ask yourself, what would be the best fundamental method of coping with it? Maintaining a free market or establishing a centrally planned socialist system?

More fundamentally, what is the appropriate method for Man to use in dealing with Nature in general? Is it the motivated and coordinated human intelligence of all individual market participants that is provided by a free market and its price system? Or is it the unmotivated, discoordinated chaos in which one man, the Supreme Dictator, or a handful of men, the Supreme Dictator and his fellow members of the Central Planning Board, claim a monopoly on human intelligence and on the right to make fundamental decisions?

Suppose even that the warming caused by Nature were such that what was required to deal with it was some sort of space program, perhaps emitting thousands of tiny mirrors that would prevent some sunlight from reaching the earth by reflecting it back into space. Suppose further that as a practical matter, given our present state of social organization, the only realistic means of carrying out such a program was through governmental action—a kind of public works project, as it were. In which circumstances, would such a program be more likely to be feasible: in those of the primitive economies characteristic of third world countries or in those of advanced industrial economies? And would they not be more likely to be feasible in an economy substantially more advanced than our own is at present?

The answer to the question of how best to cope with intolerable global warming caused by Nature is obviously the maintenance of the free market, not its replacement by Socialist central planning. Indeed, the answer is to make the free market freer than it now is—as much freer as is humanly possible. This is because while the primary reason for advocating a free market is the greater prosperity and enjoyment it brings to everyone in the course of his normal, everyday life, a major, secondary reason is to have the greatest possible industrial base available for coping with catastrophic events, whether those events be war, plague, meteors from outer space, intolerable global warming, or a new ice age.

In effect, what the environmentalists would have us do as the means of preparing for coping with a coming global warming is analogous to the imaginary absurdity of the United States in the 1930s having reduced its economy to the level, say, of Poland’s economy. Then, when World War II came, our country would have had to fight the war with horses instead of tanks and planes. In the same way, the environmentalists would have us cope with global warming by waving little fans instead of using air conditioners, refrigerators, and freezers.

Now what, if anything, changes if we assume that global warming is an unintended by-product of the human productive activities that make life possible and enjoyable? How does it possibly follow from this that the only means of stopping this much-less-than-certain outcome is by suffering the absolutely certain impoverishment and death that will come from the destruction of most of our present sources of energy?

Is there absolutely no other way to deal with global warming than the destruction of our economic system? Is that how we would deal with it if global warming were the product of Nature, and not the by-product of our activities? Would the environmentalists then ask us to engage in what in the circumstances would be a merely ritual sacrifice incapable of accomplishing anything beyond itself?

If they would not do that, then they would have to look for other alternatives as the means of coping with global warming. Why aren’t they looking for those other alternatives now? Why on earth should the first and only solution for global warming as a by-product of human activity be the scuttling of our energy base? Do we deserve to be exterminated for our unintended by-products? Must we really choose to live in poverty and misery, surrounded by death, in order to avoid excessive heat? Can absolutely no other way be found? (The likely answer is actually no more complicated than having the greater energy base required to build and power bigger and better air conditioners.)

Do you environmentalists who do not want to think of yourselves as misanthropes, as recycled Communists or Nazis, do you really want to entrust your lives and material well being, and the lives and material well being of everyone who may matter to you, to the power of government officials to tax carbon emissions and to limit the total of such emissions? Are you willing to entrust this power to today’s President (who at least has the good sense not to want it)? Do you want to entrust it to any of the candidates with a realistic chance to succeed him (who do want this power and may even crave it)? Do you want to entrust it to the members of the United States Congress? To the members of the United Nations General Assembly?

Do you want them to decide how much man-made energy is to be available to you in every aspect or your life, by their imposing carbon taxes and carbon caps? These will be taxes and constraints on you that are tantamount to adding extra dead weight to your body and to restricting your power to move your own limbs. And they will go on increasing in severity, to the point that you, or your children or grandchildren, will drop from exhaustion. For the effect of every loss of energy use is a corresponding imposition on the meager power of human muscles and the human frame. And if the impositions cannot be borne, the products that depended on the lost energy use can no longer be produced. If the environmentalist agenda is imposed, the day will come when your descendants, if they have any awareness of it at all, will look back on our time as a mythical Golden Age never to be achieved again.

Is that what you want?

It’s not too late for you to change your mind, abandon any support you may have been giving to environmentalism’s program of impoverishment and death, and come over to the side of the values of human life, wealth, and happiness—the values Mises fought for under the banner of genuine Liberalism.

Copyright © 2008, by George Reisman. George Reisman, Ph.D. is the author of Capitalism: A Treatise on Economics (Ottawa, Illinois: Jameson Books, 1996) and is Pepperdine University Professor Emeritus of Economics. His web site is www.capitalism.net and his blog is www.georgereisman.com/blog/.

ENVIRONMENTALISM IS RECYCLED COMMUNISM AND NAZISM

Here's the essential common core of hatred and destruction in the doctrines of Communism, Nazism, and Environmentalism. Only the concretes differ, not the fundamental principle of hatred for human life and happiness.

Communism: The pursuit of individual self-interest causes monopolies, depressions, and exploitation of workers by capitalists. It must be replaced by self-sacrifice for the benefit of the working class and the Socialist State. Capitalists and landowners must be exterminated for the benefit of the proletariat.

Nazism: The pursuit of individual self-interest causes racial impurity, national decline, and exploitation of German workers by Jewish capitalists. It must be replaced by self-sacrifice for the good of the Aryan master race and the National Socialist State. Jews, Gypsies, and Slavs must be exterminated for the benefit of the German Nation.

Environmentalism: The pursuit of individual self-interest causes global warming, acid rain, and ozone depletion. It must be replaced by self-sacrifice for the good of other species—our "fellow biota"—and for the good of the planet, under the auspices of international treaties and a nascent Global Socialist State: the UN. Most of the human race must be exterminated for the benefit of exploited species and the planet. (This is what the environmentalist “extremists” already openly say. The “moderates” merely want to reduce carbon dioxide emissions by 90 percent and thereby reduce the American standard of living to that of a third world country, with a third world country’s infant mortality and life expectancy.)

SAY NO TO RECYCLED COMMUNISM AND NAZISM. SAY NO TO ENVIRONMENTALISM.

Standing Keynesian GDP on Its Head: Saving Not Consumption as the Main Source of Spending

[This article is based on a portion of Chapter 15 of the author's Capitalism: A Treatise on Economics.]

According to the prevailing Keynesian dogma, consumption is the main form of spending in the economic system, while saving is mere non-spending and thus a “leakage” from the spending stream. This dogma underlies much of government economic policy in the United States, including the so-called economic stimulus package that has just been enacted. In this article, I prove, to the contrary, that consumption is not the main form of spending in the economic system and that the source of most spending is, in fact, saving. I prove my claims by starting with the very formulations of the expenditure aggregates presented by the Keynesian doctrine itself.

Thus, the simplest, core accounting relationship of Keynesian economics is that national income, which is essentially the sum of profits plus wages, is equal to the sum of consumption expenditure plus net investment.

It is only a small step from national income to gross domestic product (GDP). Essentially all one does is add business depreciation allowances to profits on the left-hand side of the equation and to net investment on the right-hand side. This last raises net investment to what contemporary economics calls gross investment. The sum of consumption plus gross investment is held to equal GDP.

In a slightly more complex formulation, government expenditure is stated as a third component of expenditure, alongside of consumption and investment. In yet a still more complex formulation, net exports are also included. These expenditure items, whether two, three, or four, are understood as paying the national income or GDP.

For the sake of simplicity, I’ll ignore net exports, which, rounded off at minus $1 trillion, represents the smallest of the four items. By far the largest single item of expenditure reported is personal consumption expenditure, which is currently running at an annual rate of about $10 trillion. The next largest item is government expenditure, currently running at roughly $3 trillion. Gross private domestic investment is reported as slightly more than $2 trillion.

These numbers add up to approximately $15 trillion, which is a rough approximation of today’s annual rate of GDP. Business depreciation allowances of roughly $1 trillion, imply net investment in the amount of approximately $1 trillion and a national income on the order of $14 trillion.

Now government expenditure is itself a species of consumption expenditure. But with or without the inclusion of government expenditure, consumption spending appears as the overwhelming source of GDP and national income: $10 trillion out of $15 trillion and $10 trillion out of $14 trillion respectively. Count government spending in with private consumption, and the figures rise to $13 trillion out of $15 trillion and $13 trillion out of $14 trillion.

It is data such as these that lead commentators routinely to make such statements as “consumption accounts for two-thirds of GDP.” The clear implication of such statements is that consumption expenditure, private or private plus government, is what constitutes the overwhelming bulk of spending in the economic system and pays the overwhelming bulk of the incomes of the economic system.

Nevertheless, this proposition is not in fact supported by the various formulas used in aggregate economic accounting. The formulas are all mathematically correct. For example, national income does in fact equal consumption plus net investment. And it is true that consumption spending almost always dwarfs net investment. Indeed, on occasion, net investment might even be zero or, still more extreme, a negative number. Yet in no case is it true in a modern economic system that consumption is the main form of spending and pays most of the incomes. The belief that it does rests on a radically incomplete, highly superficial understanding of the formulas.

Most Spending in the Economic System Is Concealed Under Net Investment

The truth is that the great bulk of spending and income payments in the economic system is concealed under net investment! Net investment is analogous to an iceberg, nine-tenths of whose volume is concealed beneath the surface. Only in the case of net investment, what is concealed can easily be much more than nine-tenths.

Net investment is the difference between two enormous monetary magnitudes, which are never radically different from one another in size and sometimes may even be approximately equal. Indeed, occasionally the one that is subtracted may even be larger than the magnitude it is subtracted from, which gives rise to negative net investment.

The monetary magnitude that is subtracted in the determination of net investment is the aggregate of all of the costs that business firms report in their income statements as subtractions from their sales revenues in calculating their profits, namely, depreciation cost, cost of goods sold, and selling, general, and administrative expenses. The monetary magnitude from which the costs are subtracted has no name in contemporary economics. I call it productive expenditure.

Productive expenditure is expenditure for the purpose of making subsequent sales. It is the expenditures made by business firms in buying capital goods of all descriptions and in paying wages. Capital goods include machinery, materials, components, supplies, lighting, heating, and advertising. In contrast to productive expenditure, consumption expenditure is expenditure not for the purpose of making subsequent sales, but for any other purpose. In the terminology of contemporary economics, consumption expenditure is described as final expenditure. Productive expenditure could be termed intermediate expenditure. Implicitly or explicitly, productive expenditure is always made for the purpose of earning sales revenues greater than itself, i.e., is made for the purpose of earning a profit.

I now must demonstrate just why net investment is in fact the difference between productive expenditure and business costs. My demonstration consists of two parts. First, a demonstration that the definition of national income as the sum of profits plus wages implies that national income also equals the sum of consumption and productive expenditures minus business costs. Second, a demonstration that the difference between productive expenditure and business costs is in fact net investment.

Let me begin with the proposition that national income equals the sum of profits plus wages. This proposition can be taken as true simply as a matter of definition. There are profits, there are wages, and the sum of the respective aggregates of each across the entire country is what we call national income.

Restatement of National Income as Sales Minus Costs Plus Wages

Now a simple but critical step is to recognize that profits are the difference between the sales revenues and the costs of business firms. The aggregate profit earned in an entire country in a year is equal to the sum of the sales revenues of all the business firms of the country for the year minus the sum of all of the costs that those business firms subtract from their respective sales revenues in calculating their respective profits.

Stating profits as sales revenues minus costs allows us to reformulate national income as the sum of sales revenues minus costs plus wages.

The next step in my demonstration is based on the realization that every dollar of business sales revenues and every dollar of wages received represents an identical dollar of expenditure by those who pay the sales revenues or wages. Thus the sales revenues of a steel company, say, represent expenditures on the part of such buyers as automobile companies. Wages received are wages paid by employers of one description or other.

From this point forward, we must look at sales revenues and wage incomes from the perspective of the buyers who pay them. In paying sales revenues or wages, the buyers can have only one or the other of two basic purposes in mind. They can be paying the sales revenues or wages for the purpose of themselves making subsequent sales. Or they can be paying the sales revenues or wages not for the purpose of themselves making subsequent sales.

Sales revenues and wages paid for the purpose of the buyer himself making subsequent sales constitute productive expenditure. Sales revenues and wages paid not for the purpose of the buyer himself making subsequent sales constitute consumption expenditure.

Examples of sales revenues constituted by productive expenditure are all the sales revenues paid by one business firm to another. It is the receipts from the sale of steel to automobile companies and of iron ore to steel companies, receipts from the sale of flour to baking companies and of wheat to flour millers. It is receipts from the sale of all goods purchased by retailers at wholesale, And, of course, it is receipts from the sale of all newly produced machines and equipment purchased by one business from another.

Examples of sales revenues constituted by consumption expenditure are the sales revenues of grocery stores, clothing stores, movie theaters, restaurants, and the like. However, even here, some portion of the sales revenues may be productive expenditures, as when a restaurant buys supplies in a supermarket or a business buys work clothes for its employees.

Examples of wage payments that are productive expenditures are all of the wages paid to the employees of business firms, from the wages of field hands, miners, and factory workers, to the wages of office secretaries, advertising executives, bank tellers, and sales clerks—the wages of all workers paid for the purpose of the employer making subsequent sales. (All wage payments and purchases of goods that are necessary to the existence or functioning of a business enterprise are to be conceived of as made for the purpose of making subsequent sales, for that is the purpose of the business enterprise itself.)

Examples of wage payments that are consumption expenditures are the wages paid to maids and baby sitters by housewives, and, among the very rich, the wages paid to butlers, personal cooks, and chauffeurs. These wages, of course, are obviously trivial in comparison with the wages paid by productive expenditure. The one substantial example of wage payments constituted by consumption expenditure are the wages of government employees. Those wages are not paid for the purpose of the government making subsequent sales.

Revenue/Expenditure Subcomponents

What we’ve done at this point is conceptualize national income in terms of its revenue/expenditure subcomponents. We’ve seen that profits plus wages equals not only sales revenues minus costs plus wages, but also, and more precisely, that it equals the sum of that part of sales revenues that is constituted by productive expenditure plus that part of sales revenues that is constituted by consumption expenditure, minus costs, plus that part of wages that is constituted by productive expenditure plus that part of wages that is constituted by consumption expenditure. The revenue/expenditure subcomponents are, of course, the two constituent parts both of sales revenues and of wages from the perspective of their respective types of expenditure, i.e., productive expenditure or consumption expenditure.

At this point, the revenue/expenditure subcomponents are grouped according to the type of revenue they represent, i.e., sales revenue or wages. National income is conceived as representing the addition of all four revenue expenditure/subcomponents, with costs subtracted from the two that are grouped together as business sales revenues.

What we need to do now is simply regroup the revenue expenditure subcomponents according to expenditure type rather than revenue type. Thus we will add that part of business sales revenues constituted by consumption expenditure to that part of wages paid by consumption expenditure. When we do this, we obtain total consumption expenditure, i.e., the “C” in the equation “National Income Equals C + I.”

We must also regroup that part of business sales revenues constituted by productive expenditure with that part of wage payments constituted by productive expenditure. When we do this, we obtain total productive expenditure, which, as I’ve said, has no designation in contemporary economics.

If we now subtract from productive expenditure the same costs that up to now we’ve subtracted from business sales revenues, the result will be net investment, the “I” in the equation “National Income Equals C + I.”

Why Net Investment Equals Productive Expenditure Minus Costs

All that remains to be shown is why productive expenditure minus costs does in fact equal net investment. At a superficial level we already know that it must if we’ve accepted the proposition that national income equals consumption plus net investment in the first place. This is because we began with what was unquestionably national income (the sum of profits plus wages) and have shown that that sum can logically be reformulated exactly as we’ve reformulated it. Thus if it’s true that national income equals consumption plus net investment and also true that it equals consumption plus productive expenditure minus costs, it follows inescapably that productive expenditure minus costs equals net investment.

However, we can do much better than this and show that the very nature of net investment implies that it equals productive expenditure minus costs. All we need do is break down productive expenditure and costs into three exhaustive subcategories respectively. Thus, we will have that part of productive expenditure which is capitalized into plant and equipment accounts, that part of productive expenditure which is capitalized into inventory/work in progress accounts, and finally that part of productive expenditure which is not capitalized but deducted as a cost from sales revenues immediately.

With respect to costs, we will have that part of costs which is depreciation cost, that part of cost, which is cost of goods sold, and that part of costs which represents productive expenditure that is deducted as a cost from sales revenues immediately. Obviously the difference between this third component of cost and the third component of productive expenditure must always be zero, since they are necessarily identical.

At least for some readers, a few words are necessary about the meaning of capitalizing productive expenditures and the relationship of such capitalized expenditures to costs. When productive expenditures are made for plant and equipment, they do not immediately appear as a cost deducted from sales revenue. Instead, they are added into a balance sheet account usually described as “gross plant and equipment,” or something very similar. A $1 million expenditure for new computers, say, is treated as a $1 million addition to this account. The computers may be depreciated over a three year period. In this case, one-third of a million dollars will appear as depreciation cost in the firm’s income statement for each of three years.

As depreciation cost is incurred in the firm’s income statement, the same amount of depreciation is added into another balance sheet account, known as “accumulated depreciation reserve,” or something very similar. Yet a third balance sheet account appears as the result of the subtraction of accumulated depreciation from gross plant. This account is the “net plant and equipment” account.

At the beginning of the first year of the computers’ depreciable life, the value of the net plant account, as far as these computers are concerned, is $1 million, representing $1 million of gross plant minus zero of accumulated depreciation. At the end of the first full year of the computers’ depreciable life, however, the net plant account will be down to $666,6667, owing to the subtraction of $333,333 of accumulated depreciation from the $1 million of gross plant. At the end of the second year, the net plant account will be down to $333,333, owing to the subtraction of twice as much accumulated depreciation from the gross plant account. At the end of the third year of the computers’ depreciable life, the value of the net plant account, as far as these computers are concerned, will be zero, because the accumulated depreciation reserve will then equal the part of the gross plant account that represents the purchase price of the computers.

The essential point here is to recognize that, other things being equal, productive expenditure for plant and equipment represents additions to the net plant accounts of business, while depreciation cost represents subtractions from the net plant accounts of business. To the extent that in the economic system as a whole the totality of such additions exceeds the totality of such subtractions, there is an increase in the aggregate value of net plant and equipment accounts. This increase is net investment in plant and equipment.

Of course, it is possible that in a given year, productive expenditure for plant and equipment might be less than the depreciation cost incurred in that year. In that case, net investment in plant and equipment would be a negative number, just as it is a negative number in the second and third years of our example concerning the purchase of computers.

The case of inventory/work in progress is similar. When expenditures are made on account of inventory, the sums in question are added into yet another balance sheet account, known as “inventory/work in progress” or something similar. Thus, for example, when a furniture retailer purchases furniture from a furniture manufacturer and brings that furniture into his warehouses or showrooms, the purchase price of that furniture is added into the retailer’s inventory account. Only as and when the furniture is sold and leaves the premises of the retailer, does a cost item appear in the retailer’s income statement. It appears as “cost of goods sold,” which is an excellent, literal description of it.

Just as purchases on account of inventory add to the inventory account, so cost of goods sold represents subtractions from the inventory account. A furniture retailer who has purchased, say, 100 sofas at a price $1,000 per sofa adds $100,000 to his inventory account. Each time he sells a sofa, he subtracts $1,000 from his inventory account and deducts that $1,000 as a cost of goods sold in his income statement. (The same principle applies to more complex cases, such as General Motors’ purchases of steel sheet. The purchase price of the steel sheet is added to GM’s inventory/work in progress account and only as the automobiles into which that steel sheet enters are sold, does GM incur cost of goods sold and make an equivalent deduction from its income statement.)

Here the essential point is to recognize that, other things being equal, productive expenditure on account of inventory/work in progress constitutes an addition to the balance sheet account “inventory/work in progress,” while cost of goods sold constitutes a subtraction from that account. To the extent that productive expenditure on account of inventory et al. exceeds cost of goods sold, the value of the inventory account is correspondingly increased and there is thus net investment in inventory (or inventory/work in progress). To the extent that productive expenditure on account of inventory et al. falls short of cost of goods sold, the value of the inventory account is correspondingly reduced and there is thus negative net investment in inventory (or inventory/work in progress).

So, hopefully, it is now clear to every reader why productive expenditure minus costs does in fact equal net investment: net investment in plant and equipment plus net investment in inventory.

Productive Expenditure Exceeds Consumption Expenditure

Productive expenditure, the sum of the expenditures for capital goods and labor by business firms, almost certainly not only exceeds consumption expenditure but does so by a wide margin. The truth of this proposition can be inferred from common knowledge about the size of business profit margins. A profit margin, of course, is the ratio of profit to sales revenues.

In the case of supermarkets, profit margins are often as low as just 2 percent. In instances of highly capital intensive investments, such as electric utilities, they may be as high as 20 percent. We will not go far wrong if we assume that on the average profit margins are 10 percent.

If profit margins are 10 percent of sales, it follows that costs are 90 percent of sales and thus that the productive expenditures that gave rise to these costs are also 90 percent of the sales. If we assume that those productive expenditures on average were divided between capital goods and labor in the ratio of 5 to 4, then for every $1 spent in buying a consumers’ good, there were 50¢ expended in buying the capital goods needed to produce it, and 40¢ expended in paying the wages of the workers needed to produce it.

However, the same story is repeated in the production of the capital goods that sold for 50¢ of productive expenditure. They will have a cost of production of 45¢, broken down into 25¢ of productive expenditure for earlier capital goods and 20¢ of productive expenditure for earlier labor. As we trace the process further and further, we reach a point at which the cumulative expenditure for capital goods itself approaches $1 and the cumulative expenditure for labor approaches 80¢ (i.e., 50¢ + 25¢ + 12.5¢ … = $1, and 40¢ + 20¢ + 10¢ … = 80¢).

These expenditures can be taken as representing not only the productive expenditures of earlier years but also as indicating the productive expenditures of the present year. Some part of today’s productive expenditures is devoted to producing consumers’ goods. Another part is devoted to the production of the capital goods that will produce consumers’ goods at a later date. A third part of today’s productive expenditure is devoted to producing the capital goods that will serve in the production of the capital goods that will serve in the production of consumers’ goods, and so on.

In any event, what we have in the present case is $1.80 of productive expenditure for every $1 of demand for consumers’ goods. And, for the reasons explained, such a relationship must be considered as typifying the economic system in any given year.

Keynesian Macroeconomics Plays with Half a Deck: Inadequacy of GDP

What all of the preceding discussion implies is that Keynesian macroeconomics is literally playing with half a deck. It purports to be a study of the economic system as a whole, yet in ignoring productive expenditure it totally ignores most of the actual spending that takes place in the production of goods and services. It is an economics almost exclusively of consumer spending, not an economics of total spending in the production of goods and services.

An accounting aggregate that would be far more appropriate to a genuine macroeconomics is what I have called gross national revenue (GNR). This is the sum of all business sales revenues plus wage payments. It also equals the sum of the consumption and productive expenditures that actually pay it.

Imagine an equation in which the sales revenues and wage incomes that constitute GNR appear on the left-hand side, while the consumption and productive expenditures that actually pay those sales revenues and wages appear on the right-hand side. If one then subtracts the aggregate of the costs that appear in business income statements from the left-hand side of the equation, sales revenues reduce to profits, and GNR thus reduces to national income. If one subtracts these costs from the right-hand side, productive expenditure reduces to net investment, and consumption expenditure plus productive expenditure reduce to consumption plus net investment.

Now if, instead of subtracting all costs on both sides, one subtracts all costs with the exception of depreciation, GNR reduces to GDP. That is, on the right-hand side, it will reduce to consumption expenditure plus what contemporary economics terms gross investment (a “gross” investment, incidentally, one of whose components is explicitly described as the net change—the net investment—in inventories).

Thus, it turns out that GDP falls far short of a measure of the aggregate expenditure for goods and services. If falls short by an amount equal to the sum of all costs of goods sold in the economic system plus all of the expensed productive expenditures in the economic system. It is these costs which must be added to GDP to bring it up to a measure of the actual aggregate amount of spending for goods and services in the economic system.

Adding cost of goods sold to contemporary economics’ “gross investment” would bring it up to true gross investment: that is, not only gross investment in plant and equipment but also gross investment in inventory as well. Adding expensed productive expenditures to this true gross investment would raise the latter up to productive expenditure.

Saving as the Source of Most Spending

My substitution of a radically new approach to aggregate economic accounting for that of the Keynesian approach, has numerous major implications. One of them pertains to the role of saving in the economic system. In Keynesian economics, saving appears as mere non-spending. This is because essentially the only spending that Keynesian economics recognizes is consumer spending. Thus, if funds are earned and are saved rather than consumed, it appears to Keynesians that they are simply not spent, i.e., are hoarded. It is on this basis that Keynesian economics describes saving as a “leakage.”

Yet the truth is that the only way that funds expended in the purchase of consumers’ goods can ever subsequently show up as productive spending for capital goods and labor is if and to the extent that the business recipients of those funds do not consume them. Only by saving the funds in question can they have them available to make productive expenditures of any kind. Productive expenditure depends on saving.

And because productive expenditure is the main form of spending, most spending in the economic system depends on saving. Even consumption expenditure depends on saving, inasmuch as saving is the basis of the payment of the wages out of which most consumption takes place.

The purchase of expensive consumers’ goods, such as homes, automobiles, major appliances, vacations, indeed, anything whose price exceeds more than a significant fraction of the income earned in one pay period, can be purchased only on a foundation of saving. Virtually no one buys a home out of current income, not even the income of an entire year. Likewise, very few people can buy a new automobile out of a year’s income, let alone out of the proceeds of just one pay check. And the same is true of many other goods. Saving is essential to the purchase of all such goods—if not the saving of the purchaser himself, then the saving of those from whom the purchaser borrows.

Implications for the “Economic Stimulus Package”

The dependence of productive expenditure on saving in turn has major implications for the so-called economic-stimulus package that has just been enacted. So too does the understanding we have developed of net investment and the role of cost of goods sold in connection both with net investment and with profits.

The supporters of the stimulus package assume that all that is necessary to increase the demand for goods and services all up and down the line, that is, at all stages of production from retailing to wholesaling, through manufacturing, to mining and agriculture, is to increase the demand for consumers’ goods—essentially by printing money and giving it to various consumers to spend. Yet if all that happened were that people spent the new and additional money in purchasing consumers’ goods, there would not be any additional demand for capital goods and labor whatever based on that new and additional money.

To demonstrate this, imagine that, precisely in accordance with the wishes of the supporters of the stimulus package, some consumer somewhere receives a thousand-dollar tax refund that is financed by the government’s creation of new and additional money. He cashes his refund check and proceeds to a nearby large shopping mall, where he buys $1,000 worth of furniture, say.

The owner of the furniture store happens to be on the premises, and, like a model Keynesian consumer, with a “marginal propensity to consume of 2/3,” he proceeds to withdraw $666.67 from his till and walks down the hall to a nearby men’s clothing store, where he spends that amount for new clothes.

The owner of the clothing store also happens to be on the premises, and he too, like another perfect Keynesian consumer with a marginal propensity to consume of 2/3, takes $444.44 out of his till and walks to a third store in the mall, where he spends that sum in buying a new television set. The owner of this store, in turn, removes two-thirds of his additional receipts and telephones his wife and in-laws to come and have dinner at a restaurant in the mall.

If this process kept on going, over and over again, there would ultimately be $3,000 of additional consumer spending. The Keynesians believe that this $3,000 would constitute new and additional net income and would increase the demand for labor and employment to that extent back through all of the stages of production leading up to the presence of consumers goods on the shelves of retailers

The spending multiplier and the alleged benefits to the demand for labor and thus employment would be even greater, according to the Keynesians, if the marginal propensity to consume were three-fourths instead of two-thirds, and greater still if it were nine-tenths instead of three-fourths. The multiplier and its benefits are allegedly restrained only by the disappearance of funds into the “leakage” constituted by saving.

Now the truth is that in order for additional consumer spending to constitute equivalent additional income, as the Keynesians believe, the only type of additional income that it could possibly constitute would be business profits, specifically the profits of the sellers of the various consumers’ goods. It would not constitute any additional wage income or the employment of any additional workers. This is because all that is present is additional business sales revenues. The income earned on sales revenues is profit, and if the additional income is to equal the additional sales revenues, it means that there will be additional profits equal to the additional sales revenues.

A further implication is that the prices of the consumers’ goods must rise, thereby depriving other buyers of consumers’ goods of the ability to buy them. This follows from the fact of more money being spent to buy the same quantity of goods.

Of course, the Keynesians will be quick to object that more goods will be sold, not the same quantity. Sellers will reduce their inventories to meet the additional demand. To the extent that this happens, prices need not immediately rise. But the reduction in inventories implies an increase in cost of goods sold and thus profit income rising at each point of additional consumer spending by equivalently less than the increase in such spending.

Thus, for example, if the seller of the furniture incurs $500 of additional cost of goods sold when a purchaser spends $1,000 in his store, his additional profit income will be only $500, not $1,000. His consumption, as a model Keynesian consumer, will therefore be only two-thirds of that amount. And similarly for all other sellers in the chain of spending and respending. The alleged “stimulus” will be radically less than the Keynesians expect and desire, e.g., not only $333.33 instead of $666.67 but also $111.11 instead of $444.44, and so on, with each subsequent round of spending reflecting not only the alleged “leakage’ of funds into saving but the effects on profit income of having to subtract cost of goods sold.

If the sellers practiced Keynesianism to the hilt, they would ignore the little matter of additional cost of goods sold and accompanying inventory depletion and simply consume in proportion to their additional sales proceeds, as though it were additional income, as Keynesianism assumes and teaches. In that case there would be $3,000 of consumption, and $1,500 of inventory decumulation.

Such behavior would set the stage not only for there being no additional demand for capital goods and labor but for there being less such demand than there was before, with the result of an actual increase in unemployment.

This is because if at some point the sellers, wanted to replace the goods they had sold, they would find that their ability to do so would be diminished, because they had consumed part of their capital. To replace that capital they would need either to raise additional capital from outside or to withdraw capital that they themselves had been advancing to others. Either way less capital would be available somewhere in the economic system and where less capital is available, business activity must shrink. The consequence is more unemployment not less.

In order for the new and additional money injected into the economic system through additional consumption expenditure to find its way back to earlier stages of production, the sellers must not consume their additional sales proceeds to any great extent. To the contrary, they need to save them to the greatest extent possible. If the furniture store owner saves and productively spends his $1,000 of additional sales revenues, he will be able give some “stimulus” to his suppliers. If they in turn save and productively expend the great bulk of their additional sales revenues, they will be able to give some stimulus to their suppliers, and so on back. Along the way, the demand for labor and employment may increase. But any such result will depend on additional saving and productive expenditure, not consumption expenditure.

The fact that if accompanied at all stages of production by heavy saving out of sales revenues, an increase in consumer spending financed by inflation can serve to increase the demand for capital goods and labor at all the stages is not a sufficient basis for recommending such a policy. In fact, what it represents is an effort to reestablish the same kind of misdirected, wasteful production that leads to a recession or depression in the first place and which then creates the appearance of a need for stimulus.

It should never be forgotten that our present problems originated in an arrangement whereby a very large amount of production, i.e., the construction of hundreds of thousands of new houses, was taking place for the benefit of people whose own production was grossly insufficient ever to allow them to pay for those houses. It is a positive good thing that that wasteful, inherently loss-making production has now ceased.

The solution is not to now attempt to create another such loss-making arrangement to take its place. Another arrangement under which producers will produce goods for the benefit of people whose own production is insufficient to enable them to afford the goods in question—people who will buy the producers’ output only with “refunds” of taxes they never even paid. The problems created by building houses for “sub-prime” borrowers cannot be corrected by now producing goods of all descriptions for “sub-prime” consumers in general.

A real solution requires making it possible for production to be directed to the needs and wants of those whose own production is sufficient to enable them to pay for the production of others.

Summary and Conclusions

I’ve shown that contrary to superficial appearance, in the most literal sense of the word “superficial,” consumption expenditure is not the main form of spending in the economic system and does not pay the national income or gross domestic product. I’ve shown that most spending in the economic system is in fact concealed under the head of net investment. However modest in size, including possibly being actually negative, net investment represents the true source of most revenue and income. That source is productive expenditure, which, I showed, is expenditure for the purpose of making subsequent sales and is represented by the spending of business firms for capital goods of all descriptions and for labor. (Consumption expenditure, in contrast, I showed is expenditure not for the purpose of making subsequent sales.)

The role of productive expenditure is concealed because net investment is the difference between it and business costs, the same costs that appear in business income statements in calculating business profits, and which do not differ very greatly from productive expenditure in size. Thus only a very small portion of the actual magnitude and importance of productive expenditure is ever revealed in conventional, Keynesian national income accounting.

I demonstrated the presence of productive expenditure behind net investment by means of a step-by-step logical demonstration of the equality between profits plus wages on the one side, and consumption plus net investment on the other. The crux of the demonstration was the restatement of profits as sales revenue minus costs, and then the breakdown both of sales revenues and wage incomes into productive expenditure and consumption expenditure. I called the resultants of the breakdown “revenue/expenditure subcomponents” and showed how the equality of profits plus wages and consumption plus net investment resulted simply from changing the order of addition of those subcomponents, from one based on revenue and income type to one based on expenditure type.

I showed on the basis of elementary business accounting principles why productive expenditure minus costs is the sum of net investment in plant and equipment and net investment in inventory. I then demonstrated why and how productive expenditure exceeds consumption expenditure and does so by a wide margin.

I presented gross national revenue (GNR) as the appropriate measure of total spending that constitutes revenue or income payments in the economic system. I showed GNR as equal to sales revenues plus wages on the left and consumption expenditure plus productive expenditure on the right. I showed how by means of the subtraction of business costs from sales revenues on the left and productive expenditure on the right, GNR reduces to national income on the left and consumption plus net investment on right. I showed the deficiencies of GDP as a measure of total spending in comparison to GNR.

And finally, I’ve shown the radical difference between my analysis and the conventional, Keynesian analysis for understanding the role of saving as a source of spending in the economic system, and have shown its relevance to the so-called economic stimulus package that has just been enacted.

Copyright © 2008, by George Reisman. George Reisman, Ph.D. is the author of Capitalism: A Treatise on Economics (Ottawa, Illinois: Jameson Books, 1996) and is Pepperdine University Professor Emeritus of Economics. His web site is www.capitalism.net.

Re: A Creditors' Protection Bill: The Legitimacy of Inserting a Gold Clause in Existing Contracts

My recent article "A Creditors' Protection Bill" has been criticized because of its call for the insertion of a partial gold clause into existing contracts, with or without the consent of debtors. The criticism is that this would be an interference with the freedom of contract.

This claim is made on the grounds that the parties may have contracted precisely on the basis of the government's having arbitrary power over the purchasing power of the monetary unit and one of them (the debtor) may want it to continue. In the words of one critic, "Lots of people contracted with the intention of taking advantage of inflation, and the counter parties are responsible for evaluating their own risk. Changing the rules of the game is cheating someone."

This criticism, which appears to be the assertion of some sort of divine right to the continuation of inflation, is based on a failure to understand what the actual rules of the game are today. Superficially, the rule is that contracts are payable in fixed sums of dollars, the purchasing power of which the government steadily depreciates through the use of its power to increase the money supply.

More fundamentally, however, the actual rule of the game today is that the purchasing power of what is paid and received in the fulfillment of contracts is determined by the government. This wider, more fundamental and abstract rule of the game remains unchanged when the government inserts a gold clause into existing contracts. And it was this rule which the parties implicitly accepted when they signed contracts in a world in which the government determines the purchasing power of money.

What the insertion of gold clauses into existing contracts signifies is the use of government power to determine the purchasing power of what is paid and received in the fulfillment of contracts in a way that diminishes the further such use of its power. Henceforth its power of money creation will not serve to enrich debtors at the expense of creditors, or at least not to the same extent. Creditors will have a measure of protection from the exercise of the government's power. The case is analogous to the government using its power to enact and maintain a Bill of Rights.

Furthermore, the fact is that no creditor has ever entered into a contract payable in a fixed sum of paper money in anticipation of the purchasing power of that money so radically declining that what he will receive is likely to be of substantially less purchasing power than what he lent. If that were the anticipation, credit markets would soon cease to exist in that money.

The existence of credit presupposes a monetary unit whose future purchasing power can be more or less be reliably estimated. When the government accelerates inflation even to the level seen in the United States in the 1970s, credit markets break down, as witness the virtual disappearance of long-term fixed rate mortgages in 1979, after a few rounds or prices rising more rapidly than could be compensated for by inflation premiums in interest rates. The market was beginning to form the idea that no inflation premium would be sufficient, because, however high, inflation could soon be even more rapid.

The implication of this is that once inflation becomes more than modest, it necessarily violates creditors' rational understanding of the terms of the contracts into which they entered. It thus represents a defrauding of creditors and therefore a violation of their freedom of contract. Stopping that process is not a violation of the freedom of contract but an attempt to uphold it.

I find it the very height of gall for anyone to believe that his freedom is any way violated because he is deprived of such opportunities as being able to pay the proceeds of a life insurance policy with less purchasing power than is required to pay for the postage stamp needed to mail said proceeds. (This is an example out of the German inflation of 1923.) If he borrowed money in this kind of expectation, then he deserves to be disappointed. His freedom is certainly not violated because he his prevented from fulfilling it. To the contrary, the freedom of those whose wealth an unrestrained policy of inflation would have brought him is given a measure of protection.

Postscript: It may be objected that the insertion of any kind of gold clause into existing contracts would serve to protect the rights of creditors only by means of shifting the violation of rights to debtors, who, in some cases at least, might be obliged to suffer unanticipated real and substantial additional burdens of debt. This objection falls if it is held in mind that the proposal I made was for the introduction only of a partial gold clause. The example I used, purely for the sake of illustration, was a 25 percent gold clause that at a price of gold of $1,000 per ounce would impose a contingent gold debt of 250 ounces on the borrower of $1,000,000. Such a gold clause would not increase the number of dollars actually owed unless and until the price of gold reached $4,000 per ounce. Twenty-five percent may be too high a percentage. Ten percent might be a better number. In that case, starting at $1,000 per ounce, the price of gold would have to reach $10,000 per ounce before the number of dollars owed by any debtor actually increased.

Such an arrangement would give debtors ample time to join with creditors in opposing increases in the quantity of paper money of such magnitude as to drive the price of gold beyond $10,000 within the life of existing contracts. It would serve simply to remove debtors from the category of a vulture-like pressure group seeking to feast on every last scrap of meat left on the financial bones of creditors. Hopefully, it would gradually serve to make debtors join with creditors in demanding an end to inflation, which would then be perceived as harmful to both groups instead of to just one.

This article is copyright © 2007, by George Reisman. George Reisman is the author of Capitalism: A Treatise on Economics (Ottawa, Illinois: Jameson Books, 1996) and is Pepperdine University Professor Emeritus of Economics. His web site is http://www.capitalism.net/.

A Creditor’s Protection Bill

Today, in the world of financial celebrity, anyone who is anyone is a billionaire. By the same token, millions upon millions of people are or soon will be mere, everyday millionaires in the United States. Millionaires are on the way to becoming a dime a dozen.

Similarly, new cars cost what new homes did only a few decades ago. Men’s neckties often sell nowadays for as much as men’s suits did not so very long ago. To have a pair of soles and heels put on a pair of shoes today costs as much as a new pair of shoes did not too many years ago.

All of this is the result of continuous inflation of the money supply by the Federal Reserve System. As a result of the “Fed’s” actions, tens and hundreds of billions of new and additional dollars have poured into the economic system, correspondingly increasing spending and driving up prices. There are more and more billionaires and millionaires and shockingly high-priced goods simply because of the flood of new and additional money coming from the Fed.

It’s not such things as “oil shocks” or diverting food crops to fuel production that’s responsible. Without the flood of new and additional money, increases in the price of oil and farm products would be accompanied by decreases in the price of practically everything else. This is because practically all of whatever additional money was spent in buying oil et al. would have to be taken away from spending elsewhere, since the overall total ability to spend in the economic system would be limited by a limited quantity of money. And the rise in the price of oil and farm products would also not be nearly as great as it has been.

To confirm the fact that the source of today’s high and rising prices lies in the rapid increase in the supply of paper currency and checkbook money, it’s helpful to calculate prices in terms of the currency sanctified by the U.S. Constitution, namely, the gold dollar. A gold dollar contains approximately one-twentieth of an ounce of gold. Today an ounce of gold sells for more than $800 (it’s actually more than $900 at the present moment). That means that one gold dollar has the value of more than $40 paper dollars, because one-twentieth of $800 is $40. The result is that the price of everything stated in gold dollars is currently one-fortieth, or less, of its price in paper dollars.

Thus, a $1million home is $25,000 in gold dollars. A $50,000 automobile is $1,250 in gold dollars, and so on. The rise in prices is the result of the fact that we express prices in paper money, whose supply can be increased virtually without limit and without cost. Prices can never rise to anywhere near the same extent when stated in gold. That’s because gold is rare in nature and costly to extract.

Today, we have a credit crisis emanating from the collapse of the real estate bubble that the Fed launched in order to cope with the effects of the collapse of the stock market bubble that it had launched only a few years earlier. Now, in order to cope with the effects of the collapse of the real estate bubble, the government and the Fed are looking for yet another program of monetary “stimulus.” This time it’s to be in the form of cutting taxes while financing an undiminished, indeed, an increased amount of government spending by means of the creation of still more new and additional money.

The Fed and the rest of the government seem to think that their job is always to be sure that the stock market averages and the price of homes is never to be allowed to fall too far below their most recent peaks, and to flood the economy with as much new and additional money as may be required to accomplish this. Keeping up housing prices is an especially remarkable goal, inasmuch as only a year or two ago, all of the complaining was about how far housing prices had climbed relative to the ability of people to afford them. One would think that a sharp reduction in home prices is the very thing needed to solve that problem and that the process needs to go a good deal further than it has, in order to do so.

For the present and the foreseeable future, there is probably nothing that will stop the Fed from continuing with its inflation. Leading pressure groups are ardently in favor of it: tens of millions of share owners want it; the great majority of businessmen large and small want it; bankers and brokers want it; homeowners want it; labor unions want it; the political establishment wants it. If there is another terrorist attack, let alone another war, inflation will be used to pay much of the cost. To the extent that the environmentalist agenda of declining energy production is imposed, inflation will be used to finance subsidies to the growing numbers of Americans who will be impoverished by it. Their expenditure of those subsidies will drive up prices for everyone else and cause further impoverishment and the need for more subsidization and for still more inflation to pay for it.

In the face of such prospects, people around the world who have been willing to hold dollars because dollars were superior to their own, more rapidly inflating currencies, will lose their desire to hold dollars. They’re already losing that desire. The world’s supply of dollars will sooner or later reside exclusively in the United States. Indeed, the reflux of dollars appears to have already begun.

The dollar has begun the kind of slide taken in the past by such currencies as the Italian lira. In the 1930s, one lira was worth 20 cents. Twenty cents in that era had a buying power equal to several of today’s dollars. Before the lira was replaced by the euro, its value was less one-twentieth of one U.S. cent. A few days food and lodging at an undistinguished hotel cost more than a million lira. The fall of the lira took place in essentially the same way that the dollar is falling today—through the reckless increase in its quantity in response to widely held beliefs in the necessity of such increase.

Is there anything that can be done to stop the potential destruction of the real value of all dollar-denominated savings and long-term contracts by a flood of inflation? Is there anything that can protect people from a possible tsunami of inflation in the United States?

There is something that could be done. There is a financial life raft, as it were, that could be made available to everyone, that would enable people to salvage at least some significant portion of the real value of their savings and contracts denominated in fixed sums of dollars. It is something much more urgently needed, aimed at a much more realistic danger, and much more feasible than efforts to control global warming, say.

What is it? It is the enactment of a creditors’ protection bill, whose essential provisions would be the insertion into all outstanding contracts of a limited, contingent gold clause, and the removal of all legal obstacles to the inclusion of such clauses in all future contracts.

Here’s an example of how it would work. Imagine someone who owns $1 million of corporate bonds that he bought several years earlier and that are scheduled to be redeemed in another 25 years. Perhaps 25 percent of this sum, i.e., $250,000, would be designated as representing the quantity of gold that the owner of the bonds could choose to receive when the bonds came due, instead of the $1 million he is presently entitled to receive at that time. The actual quantity of gold he would be entitled to receive would be the amount that $250,000 could buy at the price of gold prevailing on some specified date within 12 months prior to the enactment of the law.

If that price of gold were $1,000 per ounce, say, then the $1 million dollar contract would contain a contingent liability calling for the payment of 250 ounces of gold. This payment would be at the creditor’s option. The creditor would have the right to choose to be paid 250 ounces of gold rather than $1 million dollars.

Obviously, no creditor would exercise this option if the price of gold remained at $1,000 per ounce, let alone if it fell below $1,000 per ounce. He would not exercise it if the price of gold rose to $2,000 per ounce. Nor would he do so if it rose to $3,000 per ounce. But when and if the price of gold exceeded $4,000 per ounce, then it would be to the advantage of the creditor to choose to be paid 250 ounces of gold, or the sum of dollars then necessary to buy 250 ounces of gold, for at that point 250 ounces of gold would represent more than $1 million.

If when gold reached, say, $5,000 per ounce, the 250 ounces of gold that the creditor was entitled to would be worth $1,250,000, i.e., $250,000 more than the million he had lent. This would not represent any real gain to the creditor, however, if over the same period of time, prices in general had also increased by a factor of 5. In that case, the actual buying power of the 250 ounces of gold would be no greater than it had been when the price of gold was $1,000 per ounce and prices in general were where they were at that time.

But even in this case, the creditor would not be quite as badly off as he would have been without the protection afforded by the 25 percent gold clause. For in its absence, he would have been repaid merely his original $1 million, that now had a buying power only one-fifth as great as it was originally. With this gold clause and his consequent receipt of $1,250,000, the buying power he receives is one-fourth as great as the sum he lent.

The difference between a fourth and a fifth is, of course, not very great. It would amount to our creditor incurring a loss in buying power of 75 percent rather than 80 percent, which is not an outcome to be particularly happy about.

But the odds are great that the protection afforded by such a gold clause would be equal to more than 25 percent of the real value of the sum originally due the creditor. This is because if prices were to start rising rapidly, the price of gold would almost certainly rise even more rapidly. Thus, for example, if prices in general were to rise on the order of 5 times over the course of a decade or two, say, the price of gold might very well rise by 10 or even 20 times. In that case, the 250 ounces of gold that the creditor would have the option of choosing, would be worth $2.5 million or even $5 million. In the face of a fivefold rise in prices, these sums would have the buying power of 50 percent or even 100 percent of the real value of the sum originally due the creditor.

What would serve to make the price of gold rise faster than prices in general is that in periods of rapid inflation, and in the absence of any reliable alternative paper currency, such as the dollar once appeared to be, gold is the ideal inflation hedge for most people. Even though its ownership entails some costs of storage and safekeeping, those costs are very modest. At the same time incurring them represents a far lesser loss than does practically all the usual forms of investment in a period of rapid inflation, including ownership of common stocks and family businesses. In these cases, capital gains taxes and income taxes consume funds needed for replacement at higher prices. As a result, a growing demand for gold as an inflation hedge appears, which operates on the price of gold alongside of and in addition to the forces operating to raise prices in general. In addition, the price of gold could be increased by the desire for accumulations of gold on the part of those who had agreed to accept contingent liabilities in gold.

A potential consequence of a system of such partial gold clauses could well be the development of substantial opposition to rapid inflation on the part of debtors, however paradoxical that may sound. This is because once the number of dollars payable under gold clauses started to exceed the number of dollars originally owed, debtors would be in a position in which further inflation served to increase their burden of debt rather than decrease it. Gold prices rising more rapidly than prices in general would mean that debtors would be in a position in which the additional inflated money they took in could not keep pace with the additional money they owed. They would do better to take in less additional inflated money and not be confronted with debt obligations rising even more rapidly. (This seemingly paradoxical effect of inflation under a system of gold clauses is a matter I discuss more fully in Capitalism.)

Enactment of a creditors’ protection bill along the lines I have described should be an essential part of the near-term political agenda of all defenders of economic freedom. It would offer a potentially valuable two-fold protection against the ravages of inflation. First, it could provide substantial protection to the real value of the assets of individuals. Second, it also might also ultimately turn debtors, who typically have a vested interest in inflation, into opponents of inflation, once they came to be faced with debts payable in gold, which would become harder to repay as inflation reduced the ability of paper money to serve as the means of repayment.

The insertion of a gold clause into existing contracts should by no means be regarded as any kind of new and additional government interference with the freedom of contract. To the contrary, it would be a major step in undoing such interference. Prior to their abrogation by the New Deal in 1933, full, 100 percent gold clauses were the norm in the United States in long-term term debt contracts, and had been since the Civil War. They are something that comes about on the foundation of the rational self-interest of individuals when it is allowed to operate free of government interference.

Obviously, the degree of gold clause protection would not by any means necessarily have to be the 25 percentage points that I have chosen for purposes of illustration. If a mere 5 or 10 percent protection could be enacted into law, it would be a major first step, simply by introducing the concept of gold clauses to the present generation. And, of course, it would still afford some actual measure of protection against the possible ravages of inflation.

The parties entering into new contracts should be free to include whatever degree of gold clause protection that was mutually agreeable. What presently stops such contracts from being made are considerations both of their enforceability in the courts and their likely treatment for purposes of taxation. As just mentioned, such contracts were abrogated on a mass scale in 1933 and the Supreme Court did nothing to uphold them. To be accepted with any degree of confidence, the enforceability of new, partial gold-clause contracts would have to have the benefit at the very least of a joint resolution of Congress directing the courts to uphold them.

The gold-clause contracts would have to be exempt from any possible application of usury statutes. Such statutes might come into play when creditors ended up being repaid sums of depreciated paper dollars that were greatly in excess of the sums originally lent—e.g., being repaid $2.5 million paper dollars when one had originally lent $1 million paper dollars. The contracts would have to be interpreted in terms simply of being repaid a fixed amount of gold principal—e.g., the 250 ounces of gold in the example above—irrespective of any increase in the price of gold.

Treatment of the gold-clause contracts in this way, would preclude the payment of taxes on any paper money gains reflecting merely the repayment of larger sums of paper to maintain parity with the same physical amount of gold. Thus, for example, the $1.5 million paper gain in the repayment of $2.5 million on a $1 million loan would not be subject to any kind of income or capital-gains taxation. The applicable principle would be that the lender has merely received the same physical quantity of gold that he was always entitled to. He has no gain whatever in terms of gold. In effect, he has lent a sum of gold and has been repaid that sum, nothing more. Thus, he has no gold income or gold capital gain.

Gold-clause contracts would almost certainly become very widespread if the market could take for granted their enforceability and exemption from taxation based merely on the rise in the price of gold.

As a matter of principle, the parties entering into new contracts should be legally free to agree to whatever degree of gold-clause protection they wished, all the way to 100 percent. Nevertheless, little actual harm would likely be done, if for a short time legal limits were imposed on the percentage of the value of new contracts that could enjoy gold-clause protection. Such a limitation would probably make the enactment of gold-clause protection politically more acceptable in the beginning, since it would be an incremental change and thus not appear too radical. Even with such a restriction, the gain simply from enacting the principle of gold-clause protection would be profound, not to mention the substantive protection likely afforded to creditors.

However, even in the absence of any legal limitation, for some period of time it would almost certainly be highly advisable in most cases for the contacting parties to agree to fairly modest partial gold clauses rather than full, 100 percent gold clauses. This is because partial gold-clause protection is what will be necessary in order not only to give creditors an important measure of the protection they need, but also to avoid the development of widespread bankruptcies on the part of debtors.

The threat of debtors going bankrupt arises because continuing inflation is likely to drive the real value of gold far higher than it is today and at the same time greatly reduce the ability of earnings in paper money to pay debts stated in gold. As a result, entering into 100 or even 50 percent gold-clause contracts today, at today’s price and real buying power of gold, would be an extremely risky proposition for debtors, one likely to result in their owing amounts of gold they simply could not pay.

Avoiding near-term widespread bankruptcies in gold is essential to gaining public support for gold’s once again serving to protect the real value of contracts on a large scale. Hopefully, education about the risks of owing too much gold would serve to prevent bankruptcies in gold from being too frequent. Partial gold-clause protection is what would follow from such education and accomplish its objective.

The implication here is that the degree of gold-clause protection in contracts should increase only as the risk of further increases in the real value of gold in the economic system relative to that of paper money declines.

Gold-clauses, of course, would protect not only lenders, but also people dependent on pensions or annuities or who would be the beneficiaries of such retirement vehicles in the future. They would also protect the grantors of long-term leases of all kinds.

The widespread establishment of partial gold clauses is an essential step in the protection of the buying power of creditors. It would also be a major step on the path toward the establishment of sound money.

Of course, it is possible that the Fed will pull back from its increasingly inflationary course and reverse field as it did in the early 1980s. In that case, gold-clause contracts will simply have a status comparable to fire insurance for people whose homes do not suffer fire damage greater than their deductible. They will serve simply as a form of insurance policy. One that, unfortunately, looks like it is increasingly needed.

Credit Expansion, Economic Inequality, and Stagnant Wages

Capital in the form of credit is normally and, certainly, properly, extended out of previously accumulated savings. In sharpest contrast, credit expansion is the creation of new and additional money out of thin air, which money is then lent to business firms and individuals as though it were a supply of new and additional saved up capital funds. Its existence serves to reduce interest rates and to enable loans to be made and debts to be incurred which otherwise would not have been made or incurred. Always and everywhere, to the extent that private banks participate in the process of credit expansion, they do so with the sanction and generally with the active encouragement of the government.

Economists, above all Ludwig von Mises, have shown how credit expansion is responsible for the boom-bust business cycle and how its existence depends on deliberate government policy. Nevertheless, public opinion believes that the business cycle is an inherent feature of capitalism and that the role of government is not that of causing the phenomenon but of combating it. Indeed, as Mises observed, “Nothing harmed the cause of liberalism [capitalism] more than the almost regular return of feverish booms and of the dramatic breakdown of bull markets followed by lingering slumps. Public opinion has become convinced that such happenings are inevitable in the unhampered market economy.”

The truth is that credit expansion is responsible not only for the boom-bust cycle but also for another major negative phenomenon for which public opinion mistakenly blames capitalism. Namely, sharply increased economic inequality, in which the wealthier strata of the population appear to increase their wealth dramatically relative to the rest of the population and for no good reason.

It is not accidental that the two leading periods of credit expansion in history—the 1920s and the period since the mid 1990s—have been characterized by a major increase in economic inequality. Both in the 1920s and in the more recent period, a major cause of the increased economic inequality is that the new and additional funds created in credit expansion show up very soon in the financial markets, where they drive up the prices of securities, above all, common stocks. The owners of common stock are preponderantly wealthy individuals, who now find themselves the beneficiaries of substantial capital gains. These gains are the greater the larger and more prolonged the credit expansion is and the higher it drives the prices of shares. In the process of new and additional money pouring into the financial markets, investment bankers and stock speculators are in a position to reap especially great gains.

Since it’s so important, the main point just made needs to be repeated: credit expansion creates an artificial economic inequality by showing up in the stock market and driving up stock prices. Since the stocks are owned mainly by wealthy people, they are the main beneficiaries of the process. The more substantial and the more prolonged the credit expansion is, the larger are the gains enjoyed by wealthy people more than anyone else.

The new and additional funds injected into the economic system also soon show up in an additional demand for capital goods, such as business inventories and plant and equipment, and in an additional demand for consumers’ durable goods, such as houses and automobiles. The purchase of these latter goods, like the capital goods purchased by business firms, depends largely on credit and is encouraged by lower interest rates. It is also fed by the capital gains being reaped by wealthy individuals, which results in an especially pronounced increase in the demand for luxury housing and for luxury goods in general.

The additional demand for capital goods and consumers’ durable goods serves to increase business sales revenues and thus business profits across a wide spectrum of the economic system. Credit expansion increases profits in the economic system because the expenditure of the new and additional money in buying capital goods and labor increases the sales revenues of business firms immediately, while it increases the costs they must deduct from those sales revenues only with a time lag. This is also true to an extent of inflation that enters the economic system by means of its creators simply spending the new and additional money rather than lending it out—“simple inflation,” as Mises calls it. What is present in both kinds of inflation—credit expansion and simple inflation—is the fact that sales revenues rise as soon as new and additional money is spent, but the costs deducted from the sales revenues of any given year largely reflect outlays of money made in previous years. In those previous years the quantity of money and volume of spending of virtually all types was smaller, including the spending that shows up in the present year as costs in business income statements.

Credit expansion boosts profits more than does simple inflation because the reduction in interest rates it brings about serves to increase the time lag between the making of expenditures for capital goods and labor and their subsequent appearance as costs in business income statements. The low interest rates encourage the purchase of such things as durable machinery and the undertaking of construction projects. The kind of increase that this must bring about in economy-wide profits can be seen in the following examples.

Thus in one case, imagine that a business firm uses newly created money that has come into its hands to increase its newspaper advertising, say. Its additional expenditure will be equivalent additional sales revenue to the newspaper. It will also most likely be an equivalent immediate additional cost to it—a cost that it must deduct from its sales revenues in its very next income statement. Thus, in the same accounting period that the newspaper records additional sales revenues equal to the firm’s additional expenditure, the firm itself must record an equal additional cost of production to deduct from its own sales revenues. Obviously, in this case there is no increase in the economy-wide aggregate amount of profit. This is because economy-wide, aggregate sales revenues and economy-wide aggregate costs have both increased to the same extent.

But now imagine that the firm spends the same amount of money in buying durable machinery that will be depreciated over a ten-year period. Once again, a seller, this time the seller of the machinery, will immediately have additional sales revenues equal to our firm’s additional expenditure. But in this case, our firm will certainly not have an equally large additional cost of production to report in its next income statement. If its expenditure for the machinery was $1 million, say, then while the seller has $1 million of additional sales revenues in his next annual income statement, our firm will probably have merely $100 thousand of additional costs to report in its next annual income statement. This is because the purchase price of the machine is not charged off all at once, but only gradually, over its depreciable life. The implication of this example is that in the current year there will be an addition of $900,000 to economy-wide, aggregate profits. If our firm’s $1 million were part of an investment in the construction of a building with a forty-year depreciable life, the implied addition to economy-wide, aggregate profits would be even greater.

Such boosts to profits go hand in glove with the rise in common-stock prices and greatly reinforce them. Of course, once credit expansion comes to an end, the stimulus it gave to profits and to the stock market both disappear and at that point profits plunge and capital gains turn into capital losses. And at that point, the enemies of capitalism turn to attacking capitalism for causing depressions.

Now as the new and additional money created in credit expansion works its way through the economic system, one would expect the demand for labor and thus wage rates also to rise. This certainly does tend to happen and in the 1920s wages increased substantially in terms both of money and real buying power. They simply did not increase to nearly the same extent as the incomes of the wealthier strata of the population, nor, of course, to the extent that business profits increased.

In addition to the special stimulus given to profits, a second reason for the failure of wages to keep pace with the rise in profits, is that the encouragement given by credit expansion to the purchase of durable capital goods, particularly plant and equipment, tends to take place at the expense of funds that otherwise would be devoted to the purchase of labor services. As a result, the rise in wages is retarded at the same time that profits sharply advance. For this reason too it does not keep pace with the rise in profits.

Despite any appearances to the contrary, the rise in real wages in the 1920s was not the result of credit expansion but of rising production. Credit expansion actually operated to retard the rise in production insofar as it caused the wasteful investment of capital, i.e., what Mises calls malinvestment.

The rise in production is what prevented the prices of goods and services from rising as rapidly as credit expansion raised wage rates in terms of money. The rise in production, in turn, was based on a high degree of availability of capital funds provided by actual savings, as opposed to credit expansion, together with rapid scientific and technological progress. It was this that increased real wages, i.e., the goods and services that wage earners could actually buy with their wages.

In contrast to the experience of the 1920s, in the two great recent credit expansions, i.e., the dot.com bubble of 1995-2001 and its successor the presently collapsing housing bubble that began not long thereafter, there has been very little, if any, rise in real wages. Most commentators appear to attribute this to nothing more than the unrestrained greed of businessmen and capitalists. They apparently go on the theory that if there is anything in the economic system that breathes or moves other than at the command of the government, or other than with the active supervision and control of the government, it is proof that we live in an era of “laissez-faire.” For example, in The New York Times of December 30, 2007, in an article titled “The Free Market: A False Idol After All?,” Times columnist Peter Goodman writes:

For more than a quarter-century, the dominant idea guiding economic policy in the United States and much of the globe has been that the market is unfailingly wise. So wise that the proper role for government is to steer clear and not mess with the gusher of wealth that will flow, trickling down to the [sic] every level of society, if only the market is left to do its magic.

That notion has carried the day as industries have been unshackled from regulation, and as taxes have been rolled back, along with the oversight powers of government.

This alleged laissez-faire environment, such writers pretend, has enabled businessmen and capitalists shamelessly to enrich themselves at the expense of increasingly impoverished wage earners, to whom nothing any longer even “trickles down.” Increased free trade and “globalization,” of course, are attacked as part of the process and as greatly contributing to the stagnation or outright decline in real wages.

In sharpest contrast to such blather, in the real world there are innumerable rules and regulations enacted by the Federal Government to control virtually every aspect of economic activity. They are contained in the more than 70,000 pages of The Federal Register. The overwhelming mass of government interference described therein, and in its counterparts at the state and local level, is a glaring refutation of claims about the existence of any kind of laissez faire in the present-day world. The very description of such interference, in tens of thousands of pages of official text, is a refutation of such size and literal weight as to render any claims about laissez faire or insufficient government controls or regulations utterly nonsensical.

This truly massive body of material also suggests that the actual explanation of the stagnation in real wages is precisely an ever growing burden of government intervention in the economic system. The intervention is in the form of policies that undermine genuine saving and in numerous other ways undermine capital accumulation and the rise in the productivity of labor. Personal and corporate income taxes, the inheritance tax, the capital gains tax, and government budget deficits—all entail the taking away of funds that if left in the hands of their owners would have been heavily spent, indeed, overwhelmingly spent, in the purchase of capital goods and labor services. Instead, those funds are diverted into financing the consumption of the government and those to whom the government gives money.

Inflation and credit expansion greatly exacerbate this diversion of funds, because their effect is artificially to increase the incomes subject to these taxes and to thus to deprive business firms of the funds required to replace assets at prices made higher by the same process that increases their taxable incomes. The progressive aspect of income and inheritance taxes also worsens their effects, because incomes tend to be saved and invested the more heavily the larger they are; at the same time, substantial inheritances are more likely to be retained in the form of accumulated savings and capital than are modest inheritances.

Because of the reduced demand for labor that results from the taxation of funds that would otherwise have been used in employing labor and in buying capital goods, wages are substantially less than they otherwise would have been. At the same time, the buying power of those reduced wages is also sharply reduced in comparison with what it would otherwise have been.

It is worth pointing out that totally apart from the effect of social security in undermining the incentive to save, the sheer rise in tax rates since 1965 to pay for the system has taken away fully eight additional percentage points of the income of every wage earner whose earnings are equal to or less than the amount subject to such taxation. In 1965 the combined social security tax on wage earners and their employers was 7.25 percent, which applied to a maximum annual income of $4800. Today, the combined rate is 15.3 percent, which includes 2.9 percent for Medicare. The 15.3 percent rate currently, i.e., in 2008, applies to all wages and salaries up to a maximum of $102,000 per year. The effect of these major increases both in social security tax rates and in the amount of income
subject to them has been to reduce the take-home wages of many workers by considerably more than 8 percent.

The social security contribution of employers is a loss to wage earners, because it is a cost of employment no different than the payment of take-home wages. Financially, it is a matter of indifference to employers whether they pay this sum to the government or to their employees. The cost to them is the same. It is money that the employees could and would have had, if the government had not taken it from the employers.

The same is true of all other costs borne by employers on behalf of their workers, whether it is health insurance, day care, family leave, or whatever. The costs in question are all costs of employment, which, in the absence of such government interference, the wage earners could and would have had in their own pockets. Compelling employers to pay the costs of such things is at the expense of the workers’ take-home wages. The more such costs are imposed, the lower are take-home wages in comparison with what they otherwise would have been. The increase in such costs over time has correspondingly held down any rise in take-home wages.

Government intervention, as I’ve said, not only holds down the demand for labor and thus wages, particularly take-home wages, but it also reduces the buying power of wages. This is because the supply of capital goods is less, thanks to the diversion of funds from their purchase. The absence of these capital goods prevents the productivity of labor from being increased as much as it otherwise would have been. This in turn holds down the production both of consumers’ goods and of further capital goods. The consequence of a lesser supply of consumers’ goods is prices of consumers’ goods that are higher than they otherwise would have been and thus a buying power of wages that is correspondingly lower than it otherwise would have been.

The consequent absence of further capital goods compounds the negative effect on production, in a process that can be repeated over and over again, with each passing year. What this means is that because fewer capital goods in the form of factories and machines are available this year, the ability to produce capital goods in the form of factories and machines for the following year is reduced, because capital goods in the form of factories and machines are the means of producing further capital goods in the form of factories and machines no less than they are of producing consumers’ goods.

The buying power of wages is also reduced by all of the other laws and regulations that hold down the production and supply of goods in general and thus keep up prices. And again, there is a compounding effect. Environmental legislation deserves an especially prominent place in any list of such laws and regulations. Already, because of the restrictions it has imposed on the production of oil, coal, natural gas, and atomic power, it has served to raise the price of energy to unprecedented levels and to deprive many wage earners of the ability to buy gasoline for their cars or trucks and heating oil for their homes. To the extent that wage earners are able to pay energy prices reflecting a $100- per-barrel price of oil, their ability to buy other goods is correspondingly reduced. If the environmental movement’s agenda of radical reductions (up to 90 percent) in carbon dioxide emissions is imposed, meeting it will require absolutely crippling cutbacks in the production and use of oil, coal, and natural gas which must result in corresponding reductions in production, increases in prices, and absolute devastation for real wages.

The negative effect on production here is again a cumulative one, inasmuch as lack of energy supplies hampers the ability to find and exploit further supplies of energy. The more abundant and cheaper energy is, the greater is man’s ability to move masses of earth and to process them, thereby developing further energy supplies. Thus, government intervention that reduces energy supplies reduces the ability to find and exploit further energy supplies.

Other examples of laws and regulations holding down production are minimum-wage, prounion, and licensing legislation. These cause higher costs, higher prices, the diversion of labor from more productive pursuits to less productive pursuits, and, finally, unemployment. Subsidies of all kinds, tariffs, and consumer-product safety legislation also serve to hold down the production and supply of things and to keep up or add to their costs and prices. Again, to whatever extent production in general is curtailed, so too is the production of capital goods, with a consequent cumulative negative effect on subsequent production.

It should be clear that the resumption of an era of high and progressively rising real wages requires a radical reduction of government intervention into the economic system and the reestablishment of economic freedom.

What we have seen is that credit expansion is responsible not only for the boom-bust business cycle, as Mises showed, but also that it is a major source of artificial economic inequality and sharply increases profits relative to wages. These are processes that come to an end and are actually thrown into reverse as soon as credit expansion stops and the recession/depression that is its ultimate consequence begins. In wasting capital through malinvestment, it undermines the rise in production and accompanying rise in real wages. Despite credit expansion, real wages could still rise through most of American history, because of the substantial economic freedom enjoyed in the United States and did so even in the midst of credit expansion, as in the 1920s. In the last two episodes of major credit expansion, however, and over the last several decades as a whole, real wages have largely stagnated. This stagnation is the result of massive government intervention into the economic system that undermines capital accumulation and both the demand for labor and the productivity of labor. It is not the result of economic inequality, the profit motive, or any other aspect of the capitalist system.

I have explained all of the essential matters discussed in this article in full detail, with all of their presuppositions and implications, in my book Capitalism: A Treatise on Economics.


Copyright © 2007, by George Reisman. George Reisman is the author of Capitalism: A Treatise on Economics (Ottawa, Illinois: Jameson Books, 1996) and is Pepperdine University Professor Emeritus of Economics. His web site is www.capitalism.net.