The Social Credit Analysis of Cost

In the interests of simplicity, the Social Credit indictment of the existing economic order might be reduced to the following claim: the financial system is not self-liquidating.If we were to conceive of the financial system, which is primarily composed of the banking and cost accountancy systems, as a sort of computer software overlay that reads and represents physical economic facts by measuring economic activity, the basic idea is that instead of automatically balancing price build-up on the one hand with income distribution on the other, the existing software is designed to generate a flow of costs and hence of prices in the course of the production of any industrial good or service which will necessarily exceed the consumer purchasing power that is simultaneously being released in the form of wages, salaries, and dividends. The end result is a chronic lack or deficiency of proper or true consumer buying power relative to the goods and services on offer, i.e., of buying power that is not derived from the mortgaging of future incomes via the contracting of additional or compensatory debt from the banks.[note]N.B. Social Credit does not claim that there cannot be an equilibrium between prices and purchasing power under the existing economic system. Indeed, if equilibrium could not be achieved or at least approximated the economy would eventually collapse. This is a common misunderstanding of the Social Credit position. What Social Credit asserts is that there cannot be an endogenous or self-liquidating equilibrium under the existing system. Whenever the existing system does attain equilibrium, it is chiefly by borrowing into existence additional debt-money from the private banking system in the form of government, business, or consumer loans. The purchasing power released by these loans can then be used to compensate for the chronic deficiency of consumer incomes. But this makes equilibrium dependent on the accumulation of ever-increasing debts. Furthermore, prices are not liquidated, once and for all, by this compensatory, debt-based, purchasing power. Rather, they are merely transformed into costs which must be recovered from incomes relating to future productive activity. The inflationary implications of this state of affairs should be clear.[/note]A self-liquidating financial system would always maintain price-values and consumer incomes in an automatic balance, such that the act of producing a specified volume of goods and services would always distribute, ipso facto, sufficient purchasing power to liquidate, i.e., to cancel once and for all, the corresponding price-values. The present system is not self-liquidating precisely because it generates prices at a faster rate than it distributes the consumer income with which those prices might be met.I have already explained, in last month’s article, why this structural imbalance between prices and incomes is wrong, both ethically and pragmatically. The objective of the present article will be to elucidate what it is that is responsible for the discrepancy.Perhaps it might be best to begin by emphasizing that the particular deficiency of consumer buying power that is at issue here is NOT caused by profit-making (including profits derived from interest on loans), by the re-investment of savings in new productive enterprises, or by the deflationary policies that are often, during economic slowdowns or financial crises, adopted by financial institutions. Douglas admitted that these factors, and a few others, could exacerbate a deficiency of purchasing power in various ways, but they were not the primal cause of what has come to be known in Social Credit literature as ‘the gap’.[note]Cf. C.H. Douglas, The New and the Old Economics (Sydney: Tidal Publications, 1973), 15:“Categorically, there are at least the following five causes of a deficiency of purchasing power as compared with collective prices of goods for sale:---

1. Money profits collected from the public (interest is profit on anintangible).2.  Savings, i.e., mere abstentation [sic] from buying.3. Investment of savings in new works, which create a new costwithout fresh purchasing power.4. Difference of circuit velocity between cost liquidation and pricecreation which results in charges being carried over into pricesfrom a previous cost accountancy cycle. Practically all plant char-ges are of this nature, and all payments for material brought infrom a previous wage cycle are of the same nature.5. Deflation, i.e., sale of securities by banks and recall of loans.There are other causes of, at the moment, less importance.”

[/note]The recurring price-income gap is due instead to an accounting flaw, or rather to a pair of accounting flaws relating to how real capital, i.e., machines and equipment, is financed and how its costs are then determined relative to any consumer income that is released during its production, maintenance, or replacement.You see, there are two categories of cost that are associated with real capital: capex charges, which companies levy in order to recover the financial costs of purchasing or producing factories, machines, and other equipment, and opex charges, which companies levy in order to provide for the operating costs of that real capital, including its maintenance and depreciation or replacement charges. Together they constitute the capital cost component that figures so prominently in the price structure of any good or service that is produced using industrial methods.Under existing financial conventions, companies (or any other productive organization) have to recover the financial value of the real capital itself (in order to pay off the bank loan which is typically used to purchase or manufacture the real capital), while simultaneously recovering sufficient money, over the lifetime of its use, to cover all of the costs that are associated with that use, i.e., with the industrial consumption of the real capital. In effect, they have to charge for the real capital they employ at least twice over, once to meet the purely financial cost and once (or even more than once) to meet the costs of its actual use and consumption. We may refer to this phenomenon as ‘the double costing of real capital’.To make the situation more concrete, allow me to illustrate the basic principles at play by way of an example. My brother-in-law, who is a personal trainer and owns his own fitness company, recently borrowed 100,000 dollars from a bank to purchase exercise equipment. In order to pay off the loan (we’ll ignore the interest payments), he must collect 100,000 USD from his customers, but he must also include depreciation charges to the tune of 100,000 USD so that the machines can be replaced after they have been worn out.[note]For the sake of linguistic economy, I have often referred to the exercise tools as ‘machines’, even if the greater part of them, not being self-operating thanks to electricity or other forms of non-human energy, are more accurately described as ‘equipment’.[/note] This means that, in terms of capital costs alone, my brother-in-law must eventually recover 200,000 dollars from consumers (to say nothing of maintenance charges). Even if we assume (which is invariably contrary to fact) that the original cost of the machines was entirely distributed as income to the workers who made the machines, only 100,000 USD would have been distributed to consumers in virtue of those same machines. Clearly, 100k in consumer income cannot offset 200k in prices. If, ex hypothesi, the 100k in consumer pockets were used to pay back the 100k bank loan, both the debt and the purchasing power would cancel each other out of existence (every bank loan creates a deposit and the repayment of every bank loan destroys a deposit), but this would leave behind equipment with a price value of 100k on it that would have to figure into prices and over and against which no purchasing power had been made available.Now, if we accept the premise that the financial system should accurately or isomorphically reflect the physical realities of the economy, the double costing of real capital is clearly an error. More specifically, the capex charges do not correspond to any physical or real consumption. If they are to be treated, as our current system treats them, as separate or additional categories of cost, they are completely illegitimate.[note]One might object that even if they don’t correspond to real or physical costs, the capex charges are nevertheless legitimate because the banks are rightly entitled to have their capital loan repaid. It must be remembered, however, that the banks create the money that they lend out of nothing and that their insistence that the money that they issue must be repaid is tantamount to claiming the ownership of the money which they create, even though this money is created in reference to, or on the basis of, physical assets which they do not own or create. This is yet another way, nay the most important way, that the existing financial system fails to adequately reflect reality: it does not recognize that money or financial credit should be regarded as belonging to the community of individuals who own the real credit of the economy.  Now, since there is no purchasing power automatically created to meet the banks’ claims for capital loan repayments, it can only be obtained by borrowing more money from the banking system in the form of public, business, or consumer loans. The effect of filling the capital-created gap with more debt-money (upon which interest is charged and in exchange for which collateral must be given) is that it places the banks in the position of being the de facto beneficial owners of society’s real capital. They have, by compensating for the accounting flaw on their own terms, usurped the community’s stock of real capital for private gain. In sum, the banks are only justified in demanding the repayment of their capital loans if the financial system were to automatically distribute to consumers, and free of any additional debt, sufficient purchasing power to make such payments possible.[/note] Not only are the capex charges illegitimate, there is also, if the matter is looked at from the correct vantage point, absolutely no consumer purchasing power which is automatically created and distributed in the course of production (and in virtue of the capex charges) with which these charges might be offset and liquidated.[note]If, instead of charging the cost of capital loan repayments directly into prices, a company decides to issue shares in an IPO in order to acquire sufficient financial capital to pay off their capital loans, the effect is fundamentally the same: money earmarked for destruction in capital loan repayments must be collected from consumers even though no corresponding purchasing power was ever distributed in virtue of, or in reference to, those payments.[/note]In order to obtain a clearer picture of the role which capex charges play in the price structure of goods and services, imagine a chain of production involving a number of different firms which contribute to various stages of manufacture. Every firm in that chain which has outstanding capital loans will incorporate a charge in the price of their intermediate production to meet their repayment schedules and these will be passed on to subsequent firms. These subsequent firms, in turn, will borrow newly created debt-money from the banks to obtain their raw materials, as most day-to-day production relies on revolving lines of credit or overdrafts. Any money borrowed that is used to pay, directly or indirectly, for the capex charges of preceding firms will be destroyed in loan repayments. Thus, although this flow of producer credit that is earmarked for capex charges is contributing to the build up of prices, it never releases any purchasing power to consumers with which the capex charges can be met. For this reason, the capex component in prices might be likened to the astronomical phenomenon of a black hole. It is theorized that even light itself cannot escape a black hole once it has passed the event horizon. In the same way, money, in the form of producer credit, goes into the capex hole at various stages of production but never comes out as consumer income or in any other form. Not only that, but because each stage will typically have its own capex charges to add to prices, the hole is an ever-growing debt snowball that is passed on from producer to producer in the chain of production until it comes to rest at the retail stage where it must be liquidated by the consumer.The first accounting flaw may therefore be summarized as follows: charges are levied corresponding to the financial price-value of real capital that are entirely unrepresented by consumer income and that have no connection with the physical consumption of those productive assets.[note]If the financial system were properly designed to reflect or mirror the physical economic reality, the double costing of industry due to capex charges would be impossible. Money, in the form of producer credit, would be created at the rate of production and would only be withdrawn in prices at the rate at which that production is actually being consumed. The presence of money would indicate the presence of some physical asset or completed good, the withdrawal and subsequent destruction of money would indicate that this asset or good no longer exists, having been used up or consumed. There would be a one-to-one correspondence between money and the physical economic reality. What happens under the current system thanks to the capex charges is that the rate of consumption, as represented by the prices that have to be met, is greater than the actual rate at which the real capital is being used up. The money created in virtue of the real capital when it was produced (or its equivalent) can be withdrawn in depreciation charges, etc., as the real capital is being used up, but then there would be no purchasing power with which the capex charges can be paid.[/note]There is, however, a second problem. Not only does the financial system include an illegitimate category of cost for which no purchasing power is distributed, it also fails to provide sufficient consumer income to meet in full the legitimate capital costs that can be tied to the consumption of real capital.To revert to the example with my brother-in-law, it is true that if 100k had been distributed to the equipment manufactures as wages, salaries, and dividends, there would be enough consumer purchasing power liberated in the course of its manufacture to meet the depreciation costs of the equipment as it is consumed by my brother-in-law’s business. And it is entirely appropriate that the consumers should pay for the use of the real capital that is employed in delivering their services. However, in actual practice, whenever real capital is manufactured, the whole price-value of that capital is not distributed as income to consumers. Why? For the simple reason that these capital-producing firms also have their own capex and opex charges to levy and any producer credit they must borrow for the raw materials or services of other companies must go to cover, in part, the various capital costs of all the other businesses in the respective chains of production. In other words, perhaps only 40k dollars might have been distributed to consumers at all stages of the production of the exercise machines. Once again, how can 40k in incomes offset 100k in prices? It can’t.The second accounting flaw where real capital is concerned could therefore be summarized in this manner: since a certain proportion of the producer credit which is expended in the course of capital production, and which thus figures in the prices of capital goods and services, is locked into the producer system and never gets out into the consumer system, or at least not at the same rate that it is being locked in, the price-values built up in the course of capital production exceed the incomes that are simultaneously being distributed, thus leaving a gap between prices and incomes.In sum, the non-self-liquidating character of the existing financial system is primarily due to the nature of capital costs as these are computed under standard conventions.[note]The attentive and informed reader will have noticed that this article is an attempt to get at ‘the guts’ of the purchasing power problem revealed by Douglas’ A+B theorem, but without actually referencing the theorem. In my experience, it is easy for the theorem to be fundamentally misunderstood and this often results in an unnecessary roadblock being placed in the way of the intellectually honest inquirer.[/note] On the basis of this analysis, it should be clear that merely seeking to reallocate, whether by distributist or socialist means, the rewards of ownership and management in the direction of labour is tantamount to rearranging the deck chairs on the titanic so long as there are capital components in the prices of goods and services for which no or an insufficient volume of consumer incomes have been automatically distributed in the first place. You cannot make an aggregate insufficiency of income sufficient by re-allocating its distribution. It should also be clear that the situation is steadily degenerating. Since the general tendency of economic progress is for real capital to replace labour in the production process, capital costs are continually growing relative to labour costs as a proportion of total costs and hence of prices. In other words, not only is the financial system not self-liquidating, it is increasingly non-self-liquidating.From a Social Credit point of view, this structural and ever-intensifying gap between prices and incomes is the central social problem; i.e., it is the core technical defect which afflicts our present civilization. If it is not properly remedied in time, it may also spell the end of that civilization. Like a corrosive agent that is silently but steadily eating away at whatever is still sound in the structure and functioning of human society, the gap between prices and incomes threatens to thoroughly dissolve society’s ‘social credit’ or the power of human beings acting in association to achieve intended results.The whys and the hows of the dire situation in which we find ourselves will be the subject of next month’s article.