"Then what's the trouble?"

"Well, it looks to me as if it was the interest you expected me to pay. If I hadn't had to pay you that interest I'd have come out even."

"Not so fast. They weren't exactly equal and could not therefore have been the same thing. Even bankers have to eat. Why should he run a bank if he isn't paid to do it? Tell me, what would the effect have been if anyone else had saved part of his income instead of spending it?"

"Ohhhoh!" Perry slapped his thigh. "I see! If anyone saves income that he receives from the cycle, it is thrown out of balance and over-production results."

"Exactly. In the problem that we have just gone through I cast the banker as the thrifty villain simply because banks were the worst offenders. They charged as much interest as they could get, and spent very little on consumption, whereas the workers, by and large, had to spend all they got as they went along. But all were guilty of the economic crime of not spending all their purchasing power and thereby saving themselves into bankruptcy, even a father with his life insurance policy and baby with his penny bank."

"Wait a minute, Master Davis. It seems to me that money saved eventually finds its way back into purchasing, even after several years. It all balances out in time. There should have been some consumers spending their savings in that first cycle to make up for those who managed to save."

"There were, of course. If savings are actually tucked away in a sock, it doesn't do much harm. It balances out with just a small carry over of inventories. But most money is not saved that way. Ordinary people invest in life insurance and savings accounts. Industrialists and financiers put it into capital expansion—use it to increase production. In each case it goes into new production."

"But how can that be harmful? We have just shown that money used for production creates new purchasing power to buy the goods produced."

"That's true but you are looking at just one part of the picture. Listen to me carefully. This is the crucial point: Potential purchasing power not spent for consumption but saved and invested for production in a later cycle has appeared as cost in both cycles. When it reappears as purchasing power in the second cycle, it is needed there, and still leaves the first cycle out of balance. For example, if money saved out of your playing card cycle were saved to finance a jelly bean production cycle every shekel of it would appear as cost in the jelly beans and would be needed to purchase jelly beans. It's not available to buy playing cards. To make this exposition rigorous I should mention the possibility that capital funds are occasionally spent on consumption and that money is sometimes taken out of production entirely, but this also produces unemployment and its attendant evils. The Panic of 1907 was of this nature, artificially created by the Morgan Bank and associated interests.

"But let's get back to your playing card factory. It is in trouble. These cycles continue. Each time the bank owns a bigger piece of your business and more of your employees are out of work. Eventually they are in dire distress and private charity cannot carry the load. Congress provides relief. At first Congress tries to pay for relief with new taxes but you business men howl that you are losing money now, which is true. Taxes on everybody—such as the sales tax—rob Peter to pay Paul, and increases purchasing power not a whit. It helps a little to tax the higher bracket incomes but in the long run that inhibits production by striking at a source of capital expansion. Congress is forced to look elsewhere for money to subsidize purchasing power and provide relief, for the spread between production and purchasing power has grown enormous, more than thirty percent in your day, billions of dollars a year. Some congressman from the middle west who cut his teeth on the Bryan campaigns proposes that the government print greenbacks to provide relief for the unemployed, but the bankers condemn this as 'unsound', 'inflationary', 'radical', 'striking at the roots of our institution'. They have great political power and carry their point. There is but one thing left to do and the government does it. It borrows for relief from the banks. True, the banks have very little cash money but the same law that permitted them to lend you money out of the inkwell enables them to lend to the government with the whole United States as security, the security being represented by interest-bearing tax-free bonds. The national debt climbs sky high but the system is held together a few more years, until the banks own practically everything, even the government."

Perry ran his hand through his hair and whistled. "You paint a pretty bleak picture. What is the answer?"

"We undertook to set up a general problem which, when solved, would answer the question in all cases of 'How much money does a country need?' We set up the general production-consumption cycle and worked through some problems under the conditions of your period. We should now be able to work the problem in general terms to arrive at the general answer. I believe you could do it with a little thought, but I will state the general answer for you to inspect and approve or reject. Here it is:

A production cycle creates exactly enough purchasing power for its consumption cycle. If any part of this potential purchasing is not used for consumption but instead is invested in new production, it appears as a cost charge in the new items of production, before it re-appears as new purchasing power. Therefore, it causes a net loss of purchasing power in the earlier cycle. Therefore, an equal amount of new money is required by the country.

"This money must be a new issue, not borrowed from the banks, for there is no way to pay it back. To tax it back from the country as a whole is to destroy necessary purchasing power at a later date. To tax it back from the bondholders is a polite name for cancellation. But that was necessary and was eventually done, in a roundabout manner."

"How?"

"By paying off the bonds with new money, then getting it back with inheritance and income taxes. There are several interesting corollaries to our main proposition. Here is one, 'No economic system can create its own new capital.' That must be done by the fiat of the sovereign state. The banks can't do it, even when they are permitted to create money, as they must recover the money they create and loan, plus a charge for the service, or 'interest'. Furthermore, banks should not be permitted to create money at all, because they are, of necessity, interested only in making a profit. They will inflate or deflate the currency to make a profit regardless of the monetary needs of the country. Their interest rates are a reflection of an artificially created money market with no relation to the cost of the service. No, banks must be required to loan only deposits placed with them for that purpose, that is to say, their reserves must be 100%, not 10% as in your day. They must keep entirely separate the funds left with them for commercial exchange, i.e. commercial checking accounts, funds placed with them to invest orloan, and funds deposited for safe keeping. In such a case the customer pays for the service of checking and exchange, pays for the service of safekeeping, and receives interest on funds deposited for investment. But the banker no longer manipulates the money supply of the nation to suit his convenience.

"Furthermore, from what we defined money to be and from our examination of the production-consumption cycle, we reach the important conclusion that there is no necessary one-to-one relationship between taxes and government expenditure. If a country is expanding industrially as the United States has since it was founded, the government is obliged to put out more money than it receives in amount equal to new capital investment in order to avoid deflation. This is new money never received in taxes. In fact the Federal government need not tax at all, except as a regulatory measure. It needs no taxes for revenue. It must never tax as much as it spends or gives away, as long as production is rising. This gives the government remarkable freedom. If a new battleship or a new highway was needed in your day, the economically sound thing to do would have been to go ahead and build, paying for it with new currency. Congress should consider only two things: 'Does the country need this battleship, or road.' And 'Is the country rich enough in manpower and materials to produce it?' If both answers are yes, go ahead and issue new money to do it."