What can economic science do to get Social Credit applied?

The Catholic Action of the Archdiocese of Krakow in Poland organized a three-day conference on Social Credit in Zakopane, December 5-7, 2003, and asked us, the Louis Even Institute for Social Justice, to send representatives.

Mrs. Boucher was well suited to represent us at this conference for “a financial system at the service of the human person”, which gathered intellectuals of high level, all interested in Social Credit: engineers, economists, professors, computer scientists, and even a member of the Polish Parliament. Here is the translation of the first part of the paper presented by Mrs. Boucher at Zakopane. (Footnotes with numbers can be found at the end of the article.) The other parts will be published in future issues.

SUMMARY

C.H. Douglas maintains that a flaw in the price system causes a rapid shrinking of the purchasing power, and that it is impossible to correct this flaw in a financial system where money is made and traded for profit. According to him, the correction requires a financial system where the purchasing power of money is adjustable through a direct adjustment of the level of prices, and the general distribution of a dividend based on the national production capacity. However, this diagnosis and solution have been so far either ignored or rejected by economists of every leaning. Through the contribution of appropriate modeling and simulation methods, economic science can contribute to bring to light the distinctive features of the Social Credit theory, in order to make its understanding and acceptance easier, and thus make its application possible.

INTRODUCTION

For a long time, economists have considered the theory of value as the main object of their discipline. What determines the prices of the goods and services exchanged? For the theory of value, money is an embarrassment, all the more serious since they consider only scriptural money, which is backed by no assets, and because of that, is also called “fiat” money.

So, how could we explain this paradox of consumption and production, which makes it so that, physically speaking, consumption is lower than production (if not, there would be no growth observed), whereas, monetarily speaking, consumption is higher than production, since one can observe the inflation of prices. How can this paradox be escaped?

Like many other systems of nature, the economy is an open system where there is a flow of energy, made up of goods and services, coupled with a flow of money that goes in the opposite direction.¹ The flow of energy and the flow of money regulate and cancel each other, through a system of prices and values. Or at least, they are supposed to do so. As a matter of fact, it is difficult to explain why they only imperfectly manage to do so. For social systems, including the economic system, are very complex, much more complex that physical systems, because they are dynamic and non-linear, and are retroactive systems.2

In order to better represent and understand these systems, a system modeling-and-simulation method was conceived at the Sloan School of Management of the Massachusetts Institute of Technology at the end of the 1950s by Jay Wright Forrester, an American engineer whose contribution to research on servo systems and the conception of digital computers was huge.³ This method allows the appropriate representation of the mental model of any dynamic phenomenon.⁴ With such a method, the correct and precise representation of the mental model of the economic theory known as “Social Credit”, conceived by Scottish engineer Clifford Hugh Douglas, in 1917, becomes possible. This is a theory that has caused much ink to flow, and brought a lot of talks at the top level of economic faculties in Great Britain and other member nations of the Commonwealth, and yet, it remains ignored by the historians of economics. There is no mention of Douglas and his theory in the textbooks on the history of economic theory, although these same books mention theories that caused much less stir than Social Credit.

The paradigm

“The fate of any truth is to be ridiculed before being recognized.”

— Albert Schweitzer

First, it is important to present the many elements that represent as many premises in the reasoning that implies the diagnosis and the solution of the Social Credit economic theory. According to C.H. Douglas himself, all of his economic views are based on a few basic proposals, of which the main three are⁵:

“(a) That the financial credit pretends to be, but is not, a reflection of real credit as defined in (b);

“(b) Real credit is a correct estimate or, if it be preferred, belief as to the capacity of a community to deliver goods and services as, when, and where required;

“(c) That the cost of production is consumption.”

Real credit is a correct estimate of the capacity to deliver goods and services

The concept of real credit, for Douglas, is “a correct estimate of the rate, or dynamic capacity, at which a community can deliver goods and services as demanded”,⁶ adding that “the only possible basis of real credit is a belief, amounting to knowledge, in the correctness of the credit-estimate of a society, with all its resources, to deliver the goods and services at a certain rate.”⁷

Real credit comprises two aspects: the first is “the potential capacity under a given set of conditions, including plant, etc., of a society to do work,”⁸ and the second is “the existence of an effective demand for these goods and services.”⁹

The capacity to produce

The capacity to deliver goods and services depends on what Douglas calls “real capital”, that is to say, not only plants, buildings, tools, processes, solar power, but also “and still more important, the knowledge, organisation, and processes necessary to their application.”10

To this definition of real capital, Douglas adds — and this is a fundamental component of his economic vision — that the capacity to deliver goods and services includes semi-finished goods:¹¹ “In any manufacturing process there enters into the cost, and reappears in the price, a charge for certain items which are really rendered useless, but which form a step toward the final product. These items may be conveniently grouped under the heading of semi-manufactures when considered in relation to a more complex product, although in many cases they may in themselves, for other purposes, represent a final product. For instance, electric power used for lighting is a final product, and ministers directly to a human need, but the same energy, if used to drive a cotton mill, is in the sense in which the term is here used, a semi-manufacture.”

“Therefore, a semi-manufacture must be an asset to be accounted into an estimate of the potential capacity to produce ultimate products (which is the whole object of manufacturing from a human point of view), and with certain reservations represents an increase of credit-capital but not of wealth. This conception is of the most fundamental importance.”

This widened definition of the capacity to produce therefore comprises the cover stock at the various steps of production and distribution, and the finished goods transiting in the distribution system, both being necessary to answer the delay in production and distribution. At the production level, it is especially the semi-finished goods in stock that must be produced in advance, since the bread that is being baked cannot be made with flour that is being ground.12

Effective demand

The effective demand from the consumers is production that is desired by the consumers, that is to say, production that is made up of goods and services that answers what they need, in quantity and quality: food, clothes, housing, and other basic needs. To be effective, this demand from the consumers must be backed by money.13

According to this definition, it must be understood that the production by the population of a certain amount of capital equipment and semi-finished goods that exceeds what is needed by the population is not a production desired by the consumers, and therefore not an effective demand from the consumers, but an effective demand from the producers.¹⁴ Similarly, the production of a certain quantity of goods aimed for exportation that exceeds the quantity of imported goods is also not a production desired by the consumers, and therefore not an effective demand on their part, but an effective demand from the producers.

Effective demand is the most essential of the two components of real credit. The presence of effective demand exists before any capacity to produce whereas, even in the presence of a capacity to produce, the absence of effective demand brings about the non-use of this capacity to produce, and therefore the negation of its existence:

“It is possible to remove every factor from the industrial system, except effective demand, and some sort of industrial system, however primitive in kind (even to the extent of digging for roots and climbing for fruit) will remain, but take away the desire, the need or the belief in the ability to consume, and not a seed will be planted nor a tool employed.”15

Real credit is a social credit

Douglas wrote: “What is commonly called credit... is most definitely communal property”¹⁶ but also privately administered: “It will be necessary carefully to distinguish between the private administration of credit as a public property and what is commonly called `public administration', it being quite probable that the former is in every way preferable as a means of administration.”¹⁷

The real credit of a community is based not only on material factors, but also on the now preponderant factors of cultural inheritance and the increment of association: “The original conception of the classical economist that wealth arises from the interaction of three factors — land, labour, and capital —was a materialistic conception which did not contemplate and, in fact, did not need to contemplate, the preponderating importance which intangible factors have assumed in the productive process of the modern world. The cultural inheritance, and what may be called the `unearned increment of association”, probably include most of these factors, and they represent not only the major factor in the production of wealth, but a factor which is increasing in importance so rapidly that the other factors are becoming negligible in comparison.”¹⁸

Process and tools, as well as the organization and the knowledge that made them possible, form a cultural inheritance that belongs to the community as a whole, and not only to the workers.¹⁹

The association of men in production gives rise to an unearned increment, which is growing enormously more important than the earned increment.²⁰ The ownership of real credit is common or social because the cultural inheritance and the increment of association are commonly and socially owned: “It is both pragmatically and ethically undeniable that the ownership of these intangible factors vests in the members of the living community, without distinction, as tenants-for-life. Ethically, because it is an inheritance from the labours of past generations of scientists, organisers, and administrators, and pragmatically, because the denial of its communal character sets in motion disruptive forces, threatening, as at the present time, its destruction.”²¹

Financial credit must be the reflection of real credit

For C.H. Douglas, financial credit “is ostensibly a device by which this capacity (the real credit) can be drawn upon. It is, however, actually a measure of the rate at which an organisation or individual can deliver money. The money may or may not represent goods and services.”²² “Financial credit is a sort of reflection of this real credit in figures, and might be defined as a correct estimate of a person's or a community's ability to deliver money.”²³

The true role of the financial system is therefore to issue financial credit until it faithfully reflects real credit: “Now it cannot be too clearly emphasized that real credit is a measure of the reserve of energy belonging to a community, and in consequence, drafts on this reserve should be accounted for by a financial system which reflects that fact.”²⁴ The limit for the issuance of financial credit therefore depends upon both aspects of real credit. This limit is reached when the effective demand of the consumers is satiated, or when the producers' capacity is exhausted, whichever happens first.²⁵ This conception of financial credit as a reflection of real credit is based on a definition of money that is modern and systemic.

Money is a ticket

Classical economics defines money as a medium of exchange, as a unit of account and a reserve of value, but Douglas resolutely goes away from these definitions. According to him, money ceased being a medium of exchange over 200 years ago, for less and less people are now required for production, because of automation, technology, and other modern productivity factors. As an engineer, he views money simply as a ticket that allows his holder to obtain goods and services on demand.²⁶ For Douglas, there is no need for an absolute unit of measure of value, like the gold standard, but only the need for a ratio, a relationship between two quantities expressed in the same unit.²⁷

Basically, money is for Douglas a piece of information, or data: “The proper function of a money system is to furnish the information necessary to direct the production and distribution of goods and services.”²⁸

The polarity of the flows of money

Following the particular way Douglas conceives money, he also gives a polarity to the various flows of money. Some are positive, and others, negative: “The financial mechanism has a positive and negative aspect; the positive aspect being represented by the issue of money, and the negative aspect being represented by the exchange of the money thus issued for the goods and services, through the medium of prices.”²⁹ Money is therefore positive from the time it is issued by the banking system until it is received by the consumers, and it is negative when it leaves consumers through the mechanism of prices for goods and services, and returns to the banking system to be cancelled.

The same reasoning applies to the money that circulates only between producers: it is positive when it is issued to a producer, and becomes negative when a producer pays another producer for the goods or services he purchases from him. Taking into account that this polarity of money is important, it prevents the simple addition of units of money without regard to the direction they circulate, nor to the fact that these units of money create or settle costs.

Loan-credit and cash-credit

As for financial credit, Douglas distinguishes two forms: loan-credit and cash-credit, which correspond, respectively, to the two categories of effective demand for goods and services: the demand for capital goods, and the demand for consumer goods.³⁰ Loan-credit is either internal or external, in which case it becomes export credit.³¹ Loan-credit is repayable, whereas cash-credit is not; that is to say, loan-credit must, at some point, return to the source that issued it, whereas cash-credit does not have to return to the source that created it, although, most of the time, it will return to the banking system after having been used for the purchase of consumer goods and services.

Financial credit is also a social credit

Because it is a reflection of real credit, the ownership of the financial credit is also communal or social: “If this point of view be admitted, and I find it difficult to believe that anyone who will consider the matter from an unprejudiced point of view can deny it, it seems clear that the money equivalent of this property (cultural inheritance, etc.), which is so important a factor in production, vests in and arises from the individuals who are the tenants-for-life of it.”³²

The true cost of production is consumption

Douglas' concept of the true cost of production is a real or physical approach, and not a monetary one. From this point of view, the cost of any particular production is the total of all the costs of what has been consumed — consumer goods, semi-finished goods, capital goods — over the period this production was made.³³ Consequently, since production of all sorts over a given period of time is generally higher than the consumption of all sorts over the same period, the real cost of this production is less than the money cost. When production increases, real cost diminishes.

For Douglas, costs are net spendings of production, that is to say, the expenses resulting from money spendings for wages and bills payable at the end of the month (overhead charges). Prices increase costs by including the cost of the capital goods — and not the cost of the depreciation of the capital goods — and profit. Cash prices are the net spendings of the consumers. So, in Douglas' view, cost is the mechanism of distribution of purchasing power over an indefinite period, whereas the cash price is the mechanism of withdrawal of purchasing power at the moment the finished good is purchased on the market.³⁴

Comparing the cost and cash price, Douglas notices that the price-making is constrained by two limits: a lower limit, which is the cost, and a upper limit, which depends upon supply and demand.³⁵ According to the law of supply and demand, prices should either go up, when demand is superior to supply, and go down, when demand is inferior to supply. However, Douglas notices that this process works in only one way, the one where prices go up.³⁶

This condition is due to the fact that delays of production and distribution force producers to have stocks in advance for raw materials, semi-finished goods, and even finished goods, in such a way that a fall in prices puts them in face of a loss on all of their stocks.³⁷ This condition, fundamental in Douglas' vision, is generally ignored by economists.³⁸

Economic models are, most often, partial-equilibrium models. Even models of calculable general equilibrium, which try to simulate a market economy where prices and quantities of goods adjust to balance supply and demand, do not take into account stocks of goods. Because it is generally used to simulate the effects of a change of policy by the State, or a change in external environment, by introducing this change and adjusting the supply and demand accordingly, the model of calculable general equilibrium constitutes an appropriate means for the representation of a national economy in which Social Credit policies would be applied, provided stocks of goods and other types of stocks are modelled.³⁹

One must also note, in Douglas, a quantitative and qualitative conception of the purchasing power.⁴⁰ According to this conception, Douglas makes the distinction between real purchasing power, which is money issued from the production of consumer goods and services, and inflation of currency, which is money issued from the production of semi-finished and capital-equipment goods.

This increase in the quantity of money dilutes the purchasing power of the money issued from the production of consumer goods and service.

The real cost of production, which sets the price of consumer goods and services as being only a fraction of their production cost, is called by Douglas the Just Price,⁴¹ or real price,⁴² or real cost.⁴³ “The Just Price bears the same ratio to the cost of production as the total consumption and depreciation bears to the total production”:⁴⁴

It must be understood that production costs exclude capital costs and profits, and consequently, it corresponds only to the spendings for production.

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In future issues, Douglas' diagnosis and solution will be explained in detail, and illustrated by examples supported by simple mathematical models inspired by modeling works of the calculable general equilibrium, as well as an attempt of modeling the Social Credit principles and policies, and methodological works aimed at developing a modeling system, to represent the dynamics of economic processes as conceived by C. H. Douglas.

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Footnotes

1. Joël De Rosnay, Le Macroscope (Paris: Editions du Seuil, 1975).
2. Jay Wright Forrester, The model versus a modeling process (Cambridge, Mass.: System Dynamics Review, System Dynamics Society, 1985) 1(1), pp. 133-134.
3. Forrester, Industrial Dynamics (Cambridge: The MIT Press, 1961), 9th Edition, 1977.
4. Forrester, The model versus a modeling process, op. cit, pp. 133-134.
Forrester, Lessons from system dynamics modeling (Cambridge: System Dynamics Review, System Dynamics Society, 1987), 3(2), pp. 136-149.
5. Clifford Hugh Douglas, The New and the Old Economic (Edinburgh: The Scots Free Press, 1931), p. 5.
6. Douglas, The Control and Distribution of Production (London: Cecil Palmer, 1922) p. 10.
7. Douglas, Credit-Power and Democracy (London: Stanley Nott, 1920) 4th Edition, 1934, p. 101.
8. Douglas, Economic Democracy, (Australia: W. & J. Barr Pty, 1920), 5th Edition 1974, p. 118.
9. Douglas, Credit-Power and Democracy, op. cit., p. 102.
10. Douglas, Social Credit (Canada: The Institute of Economic Democracy, 1924), 5th Edition, 1979, p. 66.
11. Douglas, Economic Democracy, op. cit., pp. 125-126.
12. Douglas, The Monopoly of Credit (England: Bloomfield Books, 1931), 4th Edition, 1979, p. 38.
13. Douglas, Credit-Power and Democracy, op. cit.
14. Douglas, The Control and Distribution of Production, op. cit., p. 68-70.
15. Douglas, Social Credit, op. cit., p. 182.
16. Douglas, Economic Democracy, op. cit., p. 118.
17. Douglas, “Statement of Evidence submitted by Major Douglas” in Minutes of Evidence taken before the Committee on Finance and Industry (London: H. M. Stationery Office, London, vol. 1, 1931) pp. 295-307.
18. Douglas, Social Credit, op. cit., pp. 189-190.
19. Douglas, Economic Democracy, op. cit., p. 95.
20. Douglas, These Present Discontents and The Labour Party and Social Credit (London: Cecil Palmer, 1922) p. 13.
21. Douglas, Social Credit, op. cit., p 190.
22. Douglas, The Control and Distribution of Production, op. cit., p. 10.
23. Douglas, “The only real socialism” in Warning Democracy (London: Stanley Nott, 1931), 2nd Edition 1934, pp. 21-36.
24. Douglas, Economic Democracy, op. cit., p. 118.
25. Douglas, Credit-Power and Democracy, op. cit., p. 102.
26. Douglas, Money and the Price System (Canada: The Institute of Economic Democracy, 1935), 2nd Edition,1978, p. 3-4.
27. Douglas, Credit-Power and Democracy, op. cit., p. 125.
28. Douglas, Social Credit, op. cit., p. 62.
29. Ibid, p. 97.
30. Douglas, Economic Democracy, op. cit., p. 76.
31. Douglas, The Control and Distribution of Production, op. cit., p. 73.
32. Douglas, Social Credit, op. cit., p. 190.
33. Douglas, “The Application of Engineering Methods to Finance, World Engineering Congress Tokyo, 1929” in The Monopoly of Credit (England: Bloomfield Books, 1931), 4th Edition, 1979, pp. 153-167.
34. Douglas, Economic Democracy, op. cit., p. 68.
35. Douglas, The Control and Distribution of Production, op. cit., p. 14.
36. Douglas, Economic Democracy, op. cit., p. 67-68.
37. Ibid.
38. Douglas, “Statement of Evidence submitted by Major Douglas”, op. cit., p. 302.
39. Diane Boucher, Un modèle d'équilibre général calculable avec ajustement des stocks d'inventaire, Master's paper on economics (Quebec City: Université Laval, 2001).
40. Douglas, Economic Democracy, op. cit., p. 67.
41. Ibid.
42. Douglas, Credit-Power and Democracy, op. cit.
43. Douglas, “The Application of Engineering Methods to Finance, World Engineering Congress Tokyo, 1929”, op. cit.
44. Douglas, The Control and Distribution of Production, op. cit.