Tuesday, 12 August 2008

Crazy ideas: social credit file

Of the ideas that economists have to deal with every so often, one of the stranger ones is that of Social Credit monetary theory. Here in New Zealand Social Credit was once a third party with a reasonable following by voters. Even today it is still alive as part of the Democrats. Back in 1955 it was such a force that an economist at the University of Canterbury Alan Danks (later Professor and Sir) wrote a short pamphlet explaining what was wrong with the Social Credit approach to economics. The pamphlet is What Everyone Should Know about Social Credit by A.J. Danks, Christchurch: The Caxton Press, 1955. We have scanned it to a pdf file which is available here for those interested.


Bryan Spondre said...

We have a regular comment poster ,Iain Parker, at the The Rates Blog who promotes the 'social credit' approach. I will therefore read the linked PDF with interest.

Bryan Spondre
Blog Producer

Socred said...

There is nothing new in this criticism, and I addressed these criticisms in the article on Social Credit and Wikipedia in the section "Critics of the A+B theorem and Rebuttal", which is reproduced below.

"Critics of the A + B theorem and rebuttal
Critics of the theorem argue there is no difference between A and B payments, and Social Credit policies are inflationary. These criticisms are based upon the quantity theory of money, which states that the quantity of money multiplied by its velocity of circulation equals total purchasing power. Social Crediters deny the validity of this theory. Following is a brief explanation of the quantity theory of money:

MV = PQ, where
M = quantity of money in the hands of the public,
P = average level of prices, and
Q = quantity of output (that is real national product or real national income).
PQ = national product, measured in nominal (dollar) terms, and
V = income velocity of money.
That is, the average number of times that the money stock (M) is spent to buy final output during a year. Specifically, V is defined as being equal to PQ/M
Suppose that the money stock is $20 billion. Assume that, in the course of a year, the average:dollar bill and the average chequing deposit are spent twelve times to purchase final goods and services. In other words, V is 12. Then, total spending for final output is $20 billion times 12, or $240 billion. In turn, this total spending (MV) equals the total quantity of goods and services (Q) times the average price (P) at which they were sold.
But how can the same dollar be used over and over to purchase final goods? Very simply. When you purchase groceries at the store, the $50 paid does not disappear. Rather, it goes into the cash register. From there, it is used to pay the farmer for fresh vegetables, the canning factory for canned goods, or the clerk's wages. The farmer or the clerk or the employee of the canning factory will in turn use the money to purchase goods. Once more, the same money is used for final purchases. The same dollar bill can circulate round and round."[13]
The error in regards to this theory was demonstrated in a committee report to the Alberta government: “The fallacy in the theory lies in the incorrect assumption that money 'circulates', whereas it is issued against production, and withdrawn as purchasing power as the goods are bought for consumption."[14]

All money is created as a debt that needs to be repaid; consequently, money does not circulate, but instead operates in an accounting cycle. If a retailer receives money from a customer for its product, the total sum of this money is neither profit, nor income. A retailer has debts to repay, or it must replace working capital. These sums are subtracted from revenues when determining profits. Neither is the profit entirely income, as taxes must be paid, and a portion may be re-invested back into the business.

In this view, only a small percentage of money received by retailers actually distributes as income that can then be spent on goods or services. The remainder is either used to repay debts, replace working capital, or re-invested back into the firm. The fallacy is that the same dollar can "circulate round and round". Every loan creates a deposit, and every repayment of a loan destroys a deposit.[15] As such, money does not "circulate round and round" but is created and destroyed through the creation of loans and their repayment. Money is a directional flow, either creating costs, or cancelling them. If money is created in such a way that it cancels costs (i.e. the Social Credit price rebate), then an increase in the money supply can lower prices to consumers.[16]

Other critics argue that if the gap between income and prices exists as Douglas claimed, the economy would have collapsed in short order. They also argue that there are periods of time in which purchasing power is in excess of the price of consumer goods for sale.

Douglas replied to these criticisms in his testimony before the Alberta Agricultural Committee:

"What people who say that forget is that we were piling up debt at that time at the rate of ten millions sterling a day and if it can be shown, and it can be shown, that we are increasing debt continuously by normal operation of the banking system and the financial system at the present time, then that is proof that we are not distributing purchasing power sufficient to buy the goods for sale at that time; otherwise we should not be increasing debt, and that is the situation."[12]
Incomes are paid to workers during a multi-stage program of production. According to the convention of accepted orthodox rules of accountancy, those incomes are part of the financial cost and price of the final product. For the product to be purchased with incomes earned in respect of its manufacture, all of these incomes would have to be saved until the product’s completion. In the real world, earned incomes are typically spent on past production to meet the present needs of living, and will not be available to purchase goods completed in the future --goods which must include the sum of incomes paid out during their period of manufacture in their price. This does not liquidate the financial cost of production inasmuch as it merely passes charges of one accountancy period on as mounting charges against future periods. In other words, supply does not create enough demand to liquidate all the costs of production: Social Credit denies the validity of Say's Law in economics."

Those interested in Social Credit can find some essays on the subject at my own blog: