A better system of accounts would still have to count dollars, but it would not promote the error of believing that money has real value. That was Midas' mistake.
There was a real king named Midas but the name usually refers to a mythical character in Greek legend. The mythical Midas wished that everything he touched would turn to gold, and his wish was granted. Everything turned to gold -- including his wife and daughter and the food he tried to eat.
Midas forgot that money -- even gold -- has no value of its own. It's just a token we use to count the production and consumption of the goods and services that Quesnay and Smith and Marshall recognized as real wealth, and it has value only when it represents real wealth.
In the simplest form of economy goods are traded directly -- one of my fish for some of your berries, or whatever. The rate of exchange depends on how many fish I have and how many berries you have, and how much you want fish and I want berries.
But as economies developed some goods were accepted as standards of value, to the point where they were used as money. At one time Roman soldiers were paid in salt, Maya Indians of Central America used cocoa beans as currency and Chinese traders pressed tea leaves into cakes that were used as money in some areas.
These first forms of money had real value. Roman soldiers used some of the salt themselves, the Maya used some of their cocoa beans and Chinese traders brewed some of their own tea. After the concept was established some people accepted money that had only symbolic value. Natives on the island of Truk, in the South Pacific, used huge stones as money and many Indians of central North America used wampum made of seashells. Neither the stones nor the seashells had much practical use but, because they were hard to get, they were considered valuable.
Symbolic money is the standard today but some standards are so well established that we forget they are only symbolic. Even gold and silver are symbolic, because for practical purposes they have very little real value. Unless I make high-tech electronic gear and need gold to plate electrical contacts, I have no more real use for a pound of gold than I have for a pound of printed paper.
But whether it has real value or not any kind of money is useful because it's widely accepted, it's easy to store and it keeps indefinitely.
If I catch a fish I must eat it or trade it before it spoils. To trade it I must find someone who has something I want, and who wants a fish.
But anybody with money can buy my fish, and anybody who has anything I want will accept money. If I don't want anything right now, I can keep the money until I need it. In effect the value of the fish is stored in the money until I need it.
At one time I might have kept gold in a strongbox but now we keep money in countless forms. I may keep it as art or gold or jewels, as paper in my pocket, as an account in a bank or in deeds that represent ownership of property.
Conceptually, they are all the same. Once we accept the concept of symbolic money, we also accept all the symbolic forms we can agree on.
But whatever its form, symbolic money has no value other than our agreement to accept it. It's just a token and the real wealth is the fish or the berries or the shoes or the helicopter that it represents.
If money represents goods, then all the money in an economy should be just enough to buy all the goods in that economy. That's Say's law, named for the 18-19th century French economist Jean Baptiste Say who thought the value of the goods produced in a given system would always be balanced by the amount workers were paid to produce them. Because the workers would have enough money to buy all the goods on the market, all the goods would be sold and all the workers would have work.
We honor the idea as the principle of "supply and demand." When goods and money are in balance, prices are normal. When goods are plentiful or money is scarce, prices drop. When money is plentiful or goods are scarce, prices rise.
The balance is maintained because goods are continually being produced and consumed. As we eat one farmer's potatoes, another farmer is producing another crop. As my shoes wear out, someone is making a new pair. The economy is big, and consumption and production balance out.
In actual fact the money remains while the goods come and go but for conceptual purposes we can pretend that money is created as goods are created and that it decays as the goods are consumed. As Adam Smith said, the worker who creates the goods creates the wealth.
But not all goods are wealth. The potatoes that Alfred Marshall spoke of are wealth because they offer an unqualified benefit that anyone can use. If we are hungry, we can eat them. A lawyer's brief may help decide the ownership of wealth but the wealth it gives to some is taken away from others. The brief has no practical value outside its context and nobody can eat it or wear it or live in it. It may be as desirable as a winning lottery ticket, but it does not increase the store of wealth shared by the community.
Obviously the farmer's potatoes and the lawyer's brief are two distinct kinds of "goods" and we have to distinguish between them. As we observed earlier, if a farmer produces a bumper crop of potatoes our cost of living goes down but if a lawyer produces more briefs our cost of living increases.
Goods such as potatoes and computers and automobiles and canned peas are an economic benefit to the community. Other goods, such as lawyers' briefs and singers' songs and the services of the policeman who walks the beat produce social or other benefits, but they are economic costs. Let's describe the two types of goods as "benefit goods" and "cost goods."
As a general rule we could say that if an increase in the supply of a good or service would reduce the overall cost of living, that good or service is a benefit. If an increase in the supply of a good or service would increase the cost of living, that good or service is a cost.
Benefit goods are wealth. Cost goods may have cash value, but they are not wealth.
There is a caveat here because the benefits of benefit goods may be conditional. If a farmer gets a bumper crop of potatoes from his regular fields, our cost of living goes down. If he buys downtown Toronto and bulldozes the buildings to create new fields to grow more potatoes, and if he corners the market and is able to sell them at an inflated price, our cost of living will go up. In the same way one practical car in my garage is a benefit but a collection of impractical cars would be a cost. Special cases exist and we must acknowledge them, but they do not invalidate the idea.
Note that we lump goods and services together in this context. The distinction is between cost and benefit goods, and both categories include both goods and services.
Most material goods are benefits but some, like public monuments for example, are costs.
Some intellectual goods -- like designs for new machinery, some computer programs and books on farming -- are benefits but others -- like most of the services of lawyers, are costs.
Many government services are costs, but some are benefits. High-end medicine like heart transplants -- may be costs but low end medicine like general sanitation and flu vaccines are benefits.
And while we categorize goods and services as cost or benefit we have to remember that just because something is an economic cost rather than a benefit does not make it less desirable. In economic terms I might consider your heart transplant a cost, but if I need one myself I would consider it a benefit.
An economy that produced only benefit goods could survive but it would be boring. One that produced only cost goods might be interesting but the inhabitants would have no food, clothing or shelter. We need a combination of benefit and cost goods, and the ratio of one to the other is crucial.
A surplus of benefit goods is no problem but it is a waste. Many cost goods improve the quality of our lives, and we might as well have all that we can afford.
But too many cost goods is an economic disaster. When we see them as numbers in the GDP cost goods are the same as benefit goods but in real life they are costs and, if we produce too many of them, we will go broke.
Cost goods are not wealth but the people who produce them consume wealth. If they do not produce wealth themselves then the wealth they consume must have been produced by others. Much of our wealth is shared through the process I call the cascade. This is often considered to be part of the process economists call the multiplier, but it is in fact quite different.
THE MULTIPLIER AND THE CASCADE
The concept of the multiplier has been attributed to English economist John Maynard Keynes but Keynes himself attributes it to R. F. Kahn, writing in the Economic Journal which Keynes edited.[1] The idea has also been attributed to English/American economist Sir Ralph Hawtry.
The multiplier exists because one person's expense is another person's income. A farmer who grows potatoes, for example, has to buy a tractor and fuel and seed and fertilizer and other equipment and supplies to work with. Because he buys them he makes work for the people who produce them. Because most of these goods are themselves benefit goods each one produces its own multiplier, and the effect is compounded.
Before a tractor is manufactured people have to make the parts for it and before they can do that someone has to make the steel. Before that other people have to mine the coal and the iron ore, and before they can do that someone has to make the mining machines, and so-on. The multiplier goes back as far as you care to track it, and it creates benefit goods at every step.
And the farmer must also feed, clothe and house himself and his family. If he spends 90% of his gross receipts on business and living expenses then he will pass on 90 cents of each dollar he earns to others. If they all spend 90% of their income each will pass on 81 cents of the farmer's original dollar to others, and so forth. If everybody spends 90%, then each dollar the farmer is paid for his potatoes will produce $10 in new business in the economy.
But consumers who buy the potatoes in stores will pay much more than the farmer received when he dug them out of his field. The increase in price from the field to the store is the result of the process I call the cascade.
After the farmer brings the potatoes in from the field someone is paid to inspect and grade them. Someone else trucks them to a processing plant where other people wash them and package them in five and ten-pound bags, then someone else hauls the bags to a store where clerks put them on display and cashiers check them out.
Each operation adds value to the potatoes, because it's more convenient for a consumer to buy washed and packaged potatoes at a store than to buy unwashed potatoes direct from the farmer. Each operation also adds cost, because all the people who process the potatoes have to be paid.
But while we have more people working and earning money, the cascade produces no more potatoes and no new wealth has been created. The cost of the potatoes has increased and they have become more useful, but we still have only the potatoes that the farmer dug out of his field.
The cascade distributes wealth that has already been created. The cashier who checks the potatoes out of the store earns money and she will pass some of it on to others, but her salary is part of the cascade created by the farmer's potatoes, and the money she spends is a continuation of the same cascade. Conceptually, the money she earns and spends represents a share of the farmer's potatoes.
This does not denigrate the cashier's role. She performs a valid function and she earns her share of the cascade but, when we measure the economy, we must distinguish between the creation of wealth and the transfer of wealth. Both are valid functions but they are also distinct functions.
The multiplier is a side-effect of the production of wealth. The cascade is the process by which wealth is distributed.
If we did not distinguish between the multiplier and the cascade we might say that a lawyer's brief produces a multiplier too, because it creates work for a judge and for law clerks, secretaries, bailiffs and others.
But no wealth has been created. Like the cashier in the supermarket, the lawyer shares in the wealth produced by others. We know that a nation of farmers could get along without lawyers, but a nation of lawyers could not get along without farmers.
The dollars the cashier and the lawyer spend look like the dollars the farmer is paid for his potatoes but in fact they are quite different. That may sound strange but the idea that some dollars can be different from others is not new. American bankers, for example, call the money they deposit in a Federal Reserve bank high powered money, because the amount they can lend to their customers is based on the amount they have on deposit in the Fed.[2]
Money created by the production of goods must be considered to be different from the money created by the cascade. Let's call the money created by the production of wealth root dollars, and the money created by the cascade derived dollars.
The dollars the farmer is paid for his potatoes are root dollars because they start the process. The dollars the cashier is paid for her work are derived. They have the same exchange value as root dollars but, because they do not represent the creation of wealth, they are not as important to the economy as the root dollars that begin the cascade.
The root dollars the farmer is paid represent the creation of new wealth, which is added to the economy. The derived dollars the cashier is paid represent the transfer of existing wealth from one person to another within the economy. Both are valid functions but the creation of wealth increases the total amount of wealth in the economy, and the transfer of wealth does not.
Producers of benefit goods create wealth and producers of cost goods take a share of it. We need both but the production of benefit goods must come first because wealth must be created before it can be distributed. If we don't produce enough benefit goods we won't have enough wealth to distribute, but here again Midas' mistake can lead us astray.
We need enefit goods more than we need cost goods but, as a general rule, people who produce cost goods are paid more money than people who produce benefit goods. A lawyer gets more than a farmer, a politician gets more than a factory worker and a professional athlete gets more than a skilled craftsman.
And in a culture where money is the only counter we respect, it's no surprise, that our brightest young people choose careers in which they will produce cost goods rather than benefit goods. We need food, clothing, cars and other manufactured goods but, because producers of cost goods earn lots of derived dollars, we think we can afford to import all our benefit goods.
That sounds like a good idea because the people who actually produce benefit goods are not well paid. When you pay $100 for something the retailer takes about $50 of the total to cover wages, rent, promotion and profit. The wholesaler and the distributor take about $25 for their expenses and profit and the manufacturer and his suppliers get less than $25. Often much less.
If middlemen make more profits than producers, it sounds like a good idea to import most of the goods we use. Why not let foreigners produce the goods and Canadians work as middlemen?
We have to import some goods, but we can't afford to allow imports to displace the production that actually creates wealth within Canada. Imports begin a cascade that increases costs but they do not generate root dollars or create the multiplier that would produce more root dollars. If we don't produce real wealth ourselves, we have no real wealth to share among us and the wealth we share must be borrowed.
Wealth is created by the people who produce it, and the producers of imported goods live in other countries. When goods are imported no root dollars are created in Canada and we do not benefit from the multiplier. We get a cascade but this does not create wealth, it just distributes it. If the actual wealth that begins a cascade was created somewhere else, the cascade is a cost to all Canadians.
"Social Darwinists" say that when imports displace local goods that's just an example of natural selection -- that foreign producers are taking over because they are more fit to survive. That argument ignores the facts of natural selection.
"Survival of the species" means survival of the "species," not of the individual, and it may depend on the way members of the species do or do not help each other.
Adult tigers are more fit to survive than human babies. Babies have never learned to defend themselves against tigers but humanity survived the evolutionary mill because men did not allow predators to eat their children.
Because we do not protect the producers who create our wealth, Canadians now import about 60% of all the consumer goods we buy.[3] Because we import more than half of all the goods we buy, our economy is grinding to a stop.
And when we import goods we export jobs, and we also export the multiplier that creates more jobs. If my shirt were made in Canada a Canadian would have to make it, and because a Canadian makes shirts another Canadian has to make a sewing machine. Because a Canadian makes sewing machines another Canadian has to make the tools required to make sewing machines, and so-forth. When we make goods in Canada the multiplier increases Canadian business by as much as ten times the cost of the goods we make, but when we import them the multiplier works in reverse. Because my shirt was made somewhere else the Canadian shirt-maker has no need for a sewing machine, the maker of sewing machines has no need for tools and so-forth.
When we import goods we export money. Most of the money we spend at the retail level stays in Canada but at least 15% of all our consumer dollars leave the country. Consumer spending accounts for two thirds of our GDP, so in total we export more than 10% of all the cash we earn every year.
If it were just 10% of the total that would be no problem, but this is no ordinary 10%. This is the root money that is created by the production of wealth, and from which other money is derived.
Because the money that we send overseas is a small percentage of the apparent total of money in the system, Canadian governments think they can borrow to make up the difference. With an economy that turns over nearly $800 billion a year it should be no problem to borrow $10 or $20 billion at a time.
It would not, if Canada produced enough benefit goods to sustain itself. But consumer goods make up about 60% of our whole economy and we import about 60% of consumer goods. Most of the real wealth we produce in Canada comes from mines and oil wells and factories that are owned by foreigners, and the owners take most of the profits.
This is where the difference between GNP and the GDP becomes significant. The GNP counts the wealth produced by Canadian-owned companies -- in other words the wealth we produce for ourselves. The GDP counts the wealth produced by companies located in Canada, even though much of that wealth may be claimed by the foreigners who own the companies. The GDP makes us look richer than we are.
Imagine a tiny independent country with lots of foreign-owned oil wells. This country is so small that the crews that run the oil wells actually commute from outside the country, and the oil is piped directly out of the country. The natives of the country have no jobs at all and they live in abject poverty, but the GDP would show that they are all fabulously wealthy.
The GNP offers a slightly more accurate picture but it still does not measure our wealth because much of the production it counts is actually cost goods. As the numbers get bigger politicians pretend that the country is doing well, but all we know is that more money is changing hands.
Most politicians seem to believe that money is real wealth and it is partly because of this that they find it easy to justify waste.
What does it matter that they waste money if the waste produces a multiplier effect that creates wealth for the whole economy? If that were true, waste would be a positive virtue!
Governments pretend to know that we can't afford endless waste but they have not learned the most important lesson, that dollars are not wealth. It they were, we could print a few million of them for every Canadian and we could all retire.
Everybody knows that won't work but, because of the Numbers Game we don't see that the over-production of cost goods has the same effect. Real money represents real wealth and any money that does not represent real wealth devalues the money that does.
If we count only the numbers all money looks like wealth and several provincial governments hope that lotteries, casinos and slot machines will produce wealth and bring them the revenue that taxes can no longer produce. Even some local governments once believed the theory that casinos would be an "economic engine" to produce wealth in their community, but it didn't happen. In fact, casinos drain money away from legitimate business and create economic hardship in the towns where they are located.
Advocates of gambling say that the Province of Ontario gains more than a billion dollars a year in revenue from casinos near Orillia and at Niagara Falls and Windsor. If that were root money it would be good news, but casino profits are not root money. Because casinos produce no real wealth the dollars governments collect from them are derived. Casinos redistribute wealth, but they add nothing to the economy. In fact, research shows, they do considerable harm.
Midas thought gold itself had value, but he was wrong. Governments and others are wrong to think that the money they print has real value.
IMAGINED MONEY
Money has value only if it represents real wealth, and the closer it is to the production of that wealth the more value it has. Real wealth is represented by the root dollars that are earned by the production of real goods. We need derived dollars too but, like the relationship between cost and benefit goods, the relationship between root and derived dollars is crucial.
Root dollars represent the creation of wealth and derived dollars represent the distribution of wealth. The higher the ratio of root to derived dollars the more real wealth we have for each Canadian to share. When we create more derived dollars we have more money in circulation, but each dollar is worth less.
We also have a third type of money which I call imagined money. This is legal money but it is literally created by imagination.
When you borrow money from a bank the bank may not actually have any money to lend you. Banks in the U.S. have to have some money because the amount they can lend their customers is a multiple of the money they have on deposit a Federal Reserve bank. Canada has a zero reserve system, and Canadian banks don't actually have to have any money at all. Instead, they just have to keep an average balance of zero in the Bank of Canada.[4]
When you borrow money the bank writes a cheque or credits it to your account, and the money is created at that point. The bank may not actually have the money, but that's okay if enough money will come in from deposits and repayment of other loans to cover the cheque.
Like derived money, imagined money is not created by the production of goods. Unlike derived money, imagined money can start a cascade.
Derived money can't start a cascade because it's already part of one, and when derived money is passed from hand to hand the movement is a continuation of a cascade that has already been started. Imagined money is new to the system and, because it is not part of an established cascade, it starts a new one of its own.
That creates a serious danger because imagined money does not represent real wealth and money derived from imagined money does not represent real wealth.
And because of that, imagined money may upset the balance of goods and money that keeps prices stable. Most economists think that, because bank loans and credit sales are balanced by debts and because in theory they will eventually be paid off in real money, they make no difference to the economy.
That's true, up to a point. There is obviously no problem if I buy a car or a TV set on credit, but what if I borrow a billion dollars?
The money is new and, even if I will repay it some day, it's here now and it upsets the balance. The long-term effect of a big loan will depend on what I do with the money.
If I use a billion dollars of imagined money to build a factory or a block of apartment houses or a fleet of fishing boats I create new wealth. We have more money in the economy but we also have more wealth, and the balance between money and material wealth is maintained.
In this case the imagined money acts like root money and in effect the loan just shifts the sequence slightly to create the money before, rather than after, the goods are produced.
But what if I use a billion imagined dollars to buy goods that already exist? Suppose I borrow a billion to buy apartment houses or a factory or a fleet of fishing boats that someone else built ten years ago? Now we have an extra billion dollars in circulation, but no new wealth has been produced.
Further, because this billion dollars is new to the economy it creates a cascade which, in effect, multiplies it. In the end we have perhaps 10 billion new dollars in the economy, but no real wealth has been created.
The balance between wealth and money has changed and all money will lose enough value, through inflation, to restore it. There is no conceptual difference between using a billion dollars of imagined money to buy an asset that already exists, and printing a billion extra dollars to pay our debts.
We can't even assume that a billion dollars of new money will be used to buy Canadian goods. Because we import about 60% of everything we buy, and because many wealthy Canadians invest overseas, we have to assume that much of the loan that deflates our currency will be sent overseas. When it comes back, it will be used to buy our country out from under us.
A single billion-dollar loan would not make much difference to Canada's national economy but we are not dealing with a single billion dollar loan. As wheeler-dealers buy, take over and merge companies Canadian banks may issue dozens of multi-billion dollar loans in a year. Because imagined money creates a cascade, the total effect will be tens or hundreds of billions of dollars.
The flood of money creates inflation, which gives the borrower a bonus which makes it easy to pay the loan off. Because the borrower profits from inflation he can pay off the first loan and borrow another billion, to buy another established business and start another round of inflation.
Further, because wheeler-dealers who buy and sell companies tend to buy and sell established companies rather than start new ones, they seldom create any real wealth to balance the new money they pour into the system. Because their manipulations devalue all our money, the wealth they gain creates poverty for everyone else.
If I borrow to build something new the bank advances money on my production and the ultimate result will be more wealth to be shared by all. When I borrow to buy existing property the bank agrees to share everybody else's production with me. That's not fair, because the bank does not own the production it offers to share.
Governments know that unlimited loans by banks can upset the economy and they try to control the creation of money through the interest rates set by central banks. In times of inflation the interest rate is raised, to slow borrowing and the creation of money, and in times of recession the interest rate may be lowered.
The idea sounds good but it assumes that the problem is a surplus of money. In fact it may be caused by other factors, such as a surplus of imports or cost goods and a shortage of Canadian-made benefit goods, and a high interest rate may exacerbate it by pushing entrepreneurs away from long-term projects that will benefit the economy and into fields that will produce a faster return.
If I want to sell gibblgooks, for example, it might take me a year or so to build a factory to produce them, to design the product and to train workers to make them. Imported gibblgooks may cost more in the long run, but if I choose to import them I don't have to design them or build the factory or train the workers and I can get a faster return on my money.
When interest rates are high a fast return is more important than a high return, so I will import gibblgooks rather than make them.
That's counter-productive because the problem is that we import too many goods that we should make for ourselves. The high interest rates that are supposed to reduce inflation almost certainly have a negative effect on employment and, if they encourage imports over local manufacturing, they will not stop inflation.
Some pundits think tax cuts will spur business and create wealth, but that's not necessarily so. Tax cuts may spur retail trade but if the goods we buy are imported, an increase in retail trade bleeds money out of the country.
We all handle money every day but few of us really understand it. We don't have to, in our daily life.
But when we look at the economy we have to remember that money is not wealth. It's just a token, and the real wealth is the food we raise and the goods we manufacture. Because of the Numbers Game we count money, rather than the wealth that it represents, and we lose sight of reality. When we give up our farms and factories to go into businesses that produce only cost goods we get bigger numbers, but we give up the source of our wealth and we condemn most Canadians to poverty.
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