17. The cycles

17.1. Introduction⁷⁰

As early as 1916 in his first book Society and Happiness, Bernácer had not only developed the idea of an economy of unemployment, but also that the system is subject to expansion and contraction rhythms that are not random. Bernácer’s scientific background gave him a fortunate bias, I believe, in his way of interpreting economic movements. His university studies were in Physics. He was originally a business teacher, a profession that trained students in accounting. The first faculty of Economic Sciences was not founded in Spain until some 59 years after Bernácer’s birth. Bernácer was interested in physics, which he taught, although the course title was strangely convoluted as ‘Testing and Evaluation of Commercial Products’.

I say that he imposed his physics studies on his economic reasoning because he continually used sentences about forces, vectors and, above all, concepts of equilibrium and disequilibrium. For Bernácer, there were several types of equilibrium, more or less equivalent to physics concepts of stable or unstable equilibrium.

The economy can be in equilibrium even when there is unemployment and can also be in equilibrium in full employment. While classical economists believed full employment was a constant and critical situation for the system, Bernácer believed this was an extraordinary situation. Dynamic equilibrium would exist in an economy seeking a situation of stability that quickly changed its growth rate either positively or negatively.

He understood classical thought very well. Proofs of this are his sharp and insightful critiques. Price and salary flexibility make the system elastic, so that crises subside alone, with this elasticity preventing the rupture of the system. Price and wage flexibility make it possible for those who want to sell to sell and those who want to work to find jobs. This is an approximation of classical argumentation ⁷¹.

For Bernácer this flexibility does not exist and therefore the system is rigid and able to suffer the shocks and jolts of crises. This is a point, flexibility, in which he did not speak of much, at least not as much as Keynes did. There are other factors for Bernácer that make the system enormously vulnerable to crisis and that are related to international and domestic factors of the payment system. These were the gold standard and government intervention in international trade.

Contrary to the old idea that the gold standard not only internally regulated the economy, but also did so at an international level, this system is a force that contributes to propagating cyclical oscillations on rigid terrains.

All these arguments, price and wage inflexibility, the gold standard and government intervention in domestic economies (with respect to foreign trade), do not explain the cycle. They only determine the suitable institutional framework so that the forces that encourage the cycle are developed. Thus, the origin and the mechanics of those vectors that make the forces of the cycle possible must be determined.

The theory on money, on interest and general market mechanics are arguments that explain said forces. Readers should have enough knowledge now to understand these oscillatory phenomena.

Bernácer developed an entire theory on economic cycles. Haberler knew this, author of Prosperity and Depression and, of course, Robertson also had knowledge of it ⁷². This field of economic dynamics was not foreign to Bernácer. On the contrary, it is a theory that uses extraordinarily important analytical tools to construct it (theory on money, on interest, etc.) already constructed by none other than Bernácer. It is legitimate then to speak of an economic theory or, rephrased more appropriately, Germán Bernácer’s macroeconomic theory. This theory is an enormous building, independent, solidly built, in which each part depends on the rest. One can speak of different rooms, such as monetary, that are connected to other, like interest, and with many others, such as cycles. These rooms in the solid Bernacerian building are designed, in turn, around two separate but connected floors: the ordinary market and the financial market.

This building, topped by the theory of cycles, was built over a period of some forty years. He started with Society and Happiness (1916) and finished with A Free Market Economy without Crisis or Unemployment (1955). Between these two books were dozens of articles and two other books. All of his body of work has absolute and total coherency. There are no ambiguities or fickle winds that blow his scientific boat off course due to new scientific findings or events. He knew, like a doctor knows, that there is blood circulation and this is an unquestionable fact, just as there is oxygenated circulation and another that is contaminated. I refer to the monetary circuit on the ordinary market and circulation on the financial market, which are also facts. This is how his work started and how it would end ⁷³.

The logical coherence of his body of work from beginning to end is why I believe that Bernácer is one of the greatest contributors to economic science.

17.2. The aetiology of crisis⁷⁴

The first thing that is already known is that the existence of interest makes the free circulation of savings towards investment impossible. We also know that speculation intensely absorbs system savings, specifically disposable funds, towards the bottomless pit of the financial market. Interest and speculation, which both take place on the financial market, let economic crises be glimpsed.

This affirmation is not enough, given that a depressed economy is a stable economy and does not alone determine the existence of cycles. The dynamic factors of the cycles have yet to be explained.

One of the most interesting aspects of Bernácer’s work may be his explanation of the cycles, made independently of the existence and casuistry of the financial market. This new argument will be found in the financing of production activities and will also be found in his statement claiming that savings must finance fixed capital and that new money will be needed to finance working capital. If this does not happen, the system will inevitably and quickly move towards crisis.

17.3. A theoretical outline of crises

Bernácer’s early work –before 1922– displayed exuberant energy in its intellectual execution. Chapters from his book published in 1916 started by explaining income, his criticism of interest and the doctrines that deal with it, money, international trade, etc. He also analysed and explained crisis. As a theory, it was still quite incomplete (in his 1916 book), although it is very useful as a working diagram. He set forth a series of stages that establish a methodology that he would follow in future works.

You may ask why Bernácer, who so boldly wove his theories on interest and money, did not execute a similar work on crisis. The reason is obvious. To construct a theory on crisis, he needed precise analytical tools in his hands, such as the theory on money and on interest, which would be rigorously set forth in the twenties (1922-25). He also needed highly-skilful hands so that with imagination, skill and exactitude, he could construct a solid and elegant argument. He may not have possessed these conditions as a young scientist of 33 just starting to work.

For the moment, let’s take another path. I will start by laying out his initial work on crisis in the book Society and Happiness and then move on to the exposition on crisis, but interwoven with the threads of his theories on interest, on money, on savings, on disposable funds, etc. The aim of this section is to show the interrelation existing between several variables, each of which has been explained earlier. Readers are forewarned that old arguments in this book will be repeated. I prefer reading ease and comprehension, even if it may be monotonous, over possible surprise and disorientation.

17.3.1. The design of crisis

Undoubtedly, crises are preceded by periods of great commercial activity that last a long time. Later, other phases in the cycle occur that are quite short. In fact, producers quickly find that their products are not selling, loans become expensive and business obligations are not fulfilled. This is the first phase of crisis. One gets the feeling that the system’s speed and precipitation to fix things is what pushes society towards crisis. Subsequently, normality is re-established.

There are many factors that slowly accumulate in expansion periods that suddenly explode. This is when the demand for consumer and capital goods declines, while manufacturing production simultaneously continues. The reality becomes clear through overproduction and weakness in demand that, in this case, are exactly the same. We need an explanation from Bernácer about how it is possible that demand drops, when theoretically income does not, because of increased production that in the early days of crisis does not stop.

The study of crisis is divided into four parts:

1) Preparatory phenomena

2) Decisive phenomena

3) Critical phenomena

4) Revival phenomena

Preparatory phenomena

The symptomatic events of this period develop almost simultaneously. Nonetheless, a frequency will be established in order to help with systematisation.

Drop in the capitalisation rate of ‘Assets’

Bernácer called savings ‘assets’. He followed a very typical convention of his education in accounting of calling what remains of revenue after part has been spent ‘assets’.

In periods of economic boom, needs continue to increase and are satisfied. Production, which provides satisfaction for these needs, also increases. Revenues and assets increase. Soon these assets are assigned to buying lands and other fixed-income securities. There are reasons that strengthen this action: One of them could be placements in financial assets, which are monetarily profitable; another could be saturating the factors of production that are being used to the limit and that, like lands, are avidly fought for by entrepreneurs, making their market price go up. Land and other profitable assets, which are strongly demanded, are not supplied with the same force, given that there is no reason, in principle. This is how when the prices of fixed-income assets rise, including the earth as the original producer of land, actual income or interest descends. Bernácer said the following: ‘Actual interest accrued for assets descends’. He used ‘assets’ referring to savings. It is an accountant’s term.

Intensification of industrial activity and speculation

Speculation feeds itself. Desirous of collecting fast speculative earnings, savings turns more energetically to sterile fixed-income assets, helping them go up and maintain their market price. This ascending market price gathers the energy of cash assets, a name Bernácer gave to disposable funds. The word ‘Assets’ is an accounting entry that indicates the difference between revenues and expenses that will go towards financing fixed capital. But not all of it executes this operation, as a part remains that frustrates this capitalisation, which are the cash assets and the fund that enlivens the speculative market.

As readers can surely divine, total system savings is the asset, as well as capitalised savings. He called savings earmarked for speculation cash assets, which are our familiar disposable funds.

When the market price of these fixed-income assets goes up (including property and lands), interest drops, favouring industrial activity. This encourages reluctant and marginal companies to invest. Companies bravely produce; hiring more employees and current employees working overtime, which entails more production income for the system.

However, an event will interrupt this productive glee. In the frenzy of both production and demand, everything is produced and everything is demanded, including ghost, bad and useless businesses. And even bold and dangerous speculation is carried out. Speculation, besides feeding assets, resorts to credit. What would Bernácer, who remembered the speculative crisis of 1907, have thought about the speculation preceding 1929, during which swamplands were sold, as well as other non-existing ones.

Elevation of prices

Money that is liquid, which is increasingly larger, either goes to the speculative market or to attend to new expenses. Let me clarify something. What Bernácer called ‘cash assets’ are liquid savings in this state, capable of being used for any end, either productive or speculative. They are disposable funds, without doubt, only that in Bernácer’s work starting in the twenties, disposable funds are the part of savings that are not capitalised, and as such, only have one path: the speculative market.

I said that prices of goods go up; this encourages greater production to be generated, which is employees’ income. It has a similar effect, he said, to introducing larger amounts of money. This means that there can be larger production incomes without needing to create new money. In Bernácer, we see an income-based theory, as he called it, compared to a merely quantitative one, that determines a different rhythm in economic theory, as Keynes would demonstrate later in 1936.

Entrepreneurs, stimulated by profits, increase their production activities, for which they hire new employees. This mass of workers, upon receiving increasingly higher wages, will demand more basic commodities, which will contribute to these products’ prices going up. Logically, there will also be speculation with these essential products.

Shortage of basic supplies

The rise in prices of basic commodities should stimulate their production, but agricultural production and construction require a long time to increase, so that there is a gap between supply and demand. Furthermore, there is some tension between demand and the desire to keep the market in scarcity. In the end, prices go up but not production or consumption. The high price of living restricts the demand for manufactured products, exactly those products that were stimulated during the industrial boom.

Lack of outlets and shortage of available assets

Industrial overproduction becomes dormant in the system. Entrepreneurs tend to increase production seeking higher returns. If more is produced, there are better scales, stated Bernácer lucidly: ‘Manufacturers who double production can do so without their expenses doubling.’ These economies of scale in production are achieved by large businesses that have large concentrations of capital (and savings as well naturally). These large companies elbow out small businesses while simultaneously inciting other large businesses to do the same. This small journey through the real economy, out of Bernácer’s few adventures, concludes with the statement that production grows excessively.

If, as he always stated, costs simply represent the production income of a production agent, greater production will indicate greater production than income or demand. This seemingly logical statement is very necessary, given that the young Bernácer would have to be told that lesser income, next to greater production, means more products per unit of income, provided that prices are flexible.

I believe Bernácer was referring to the issue that employees centre on demanding basic commodities like clothing, food, etc., which causes tension in the market. Proof of this are his subsequent words: ‘…everything would be resolved by the appearance of new needs that incite the production of new goods, deviating production resources towards this production, as well as towards this increased demand.

The opposite happens, as the consumption of basic commodities entails large expenditures of money, distracting them from the demand for manufactured products. The prices of these goods drop and stop being gainful. Then the entrepreneurs’ difficulties start as they try to get rid of their products, either by providing instalment plans for long payment periods, stockpiling them waiting for better times, etc. Cash assets or disposable funds that used to go to industry seeking profitability now flee fearfully from it. However, the seeker of savings or cash assets, in short the entrepreneur, seeks more resources that let him survive, bearing in mind his lack of ability to self-finance. The strain now moves to the capital market (misnamed capital market, given that it is money or rather savings or, employing the primitive terminology of Bernácer, cash assets). Greater demand than supply entails an increase in the price of money, or interest. One of the differences that makes Bernácer so different from others is precisely the moment when the crisis starts. For some, when the prices of products supplied fall, the demand for entrepreneurs’ savings decreases, since it no longer makes sense to put money into a ruined business. For Bernácer, it is the law of survival that stops the entrepreneur from dying, motivating them to continue requesting monetary resources. With respect to this point, the demand from money, far from decreasing, actually increases and becomes more desperate. The following comment is worth examining carefully.

The phenomenon starts, he said, from the shortage of money. He then added –and this clarification is the most important– that it is not the money that becomes scarce, but ‘…the ratification of available assets’. He was clearly referring to the system’s capacity to generate savings. In my opinion and Bernácer’s, what is disposable and not spent is loaned. Savings are logically the thing that is lent. This is why he said that it is not money that becomes scarce, since that does not make sense. His words are: ‘Money is not scarcer, there is no reason it would be,’ (Society and Happiness, page 247). The monetary mass is the same as before, but an increasingly greater part represents wages of employees and other participants in production, and these higher payments almost totally go to expenses, with increasingly less savings being formed. In short, savings are not developed in the same proportion as before, but in a lesser proportion. The high price of living and speculation in basic commodities imposes greater consumption and less saving. Due to the freezing of capitals, due to the lack of outlet for products and the difficulties of meeting loan payments, the assets that were employed in industry are not replaced with the same ease.

The money market is nothing more than the overall market of cash assets, liquid savings or disposable funds. If the system has little ability to generate savings, even though the total amount of money is the same, savings becomes scarce, making interest rise and making production difficult. This is an early and solid Bernacerian argument, different from the classical one and even more different from the Keynesian argument that would appear 20 years later (1936).

Everything is prepared for crisis to explode.

Decisive phenomena

With the seed of crisis planted, any fortuitous event can make it erupt. Some economists believe, mistakenly, that the overall source of crises is a chance event. In the speculation of a basic commodity or another product, such as copper that was the object of intense speculation in 1907, the change of custom’s tariffs, etc. are events that act as detonators to precipitate crisis. To Bernácer, the most general cause that encourages crisis is the lack of food or basic products ⁷⁵.

In this state of price increases and scarcity of basic commodities, any disturbance to this market brings along absolute insufficiency. Producers and profiteers are interested in price increases, much more interested naturally than in greater production to meet human needs.

Good or bad crop harvests are a further ingredient that aids explanations about crisis, but only complementarily. For example, poor crops during the preparatory period (1^st) could aid in the eruption of crisis. Assisting his work are the explanations of W.S. Jevons in the late 1800s about the influence of sunspots on crops and crops on businesses. This demonstrates that they were issues of great interest for economists a long time ago. They must also take place in a period during which the causes of crisis are strengthened and tense.

It is clear that within the determining causes (2^nd) that tip the balance towards crisis, there can be circumstances that must really take place in the preparatory period. I will restate this. Given a preparatory period that generates the causes of crisis that will break out in the determining period, this latter period can also contain originating causes that are not only the detonators I mentioned that make the crisis explode. Thus, if there is a period of intense prosperity during which the omens of crisis slyly multiply, after it has passed, another cause may arrive that makes it explode. One example of this is cotton speculation after the American Civil War, the aforementioned copper speculation, of gold, etc. whose speculation encouraged resources to be placed (before not profitable) into operations and even new ones to be sought.

As can be seen, the profitability of the last ones will be low and of the first ones high. But when speculation stops, prices drop and operations stop being profitable that were profitable in the speculation period. Many businesses go bankrupt, many workers are unemployed just like the business owners, capitals cannot be amortised and a decapitalisation process is generated in the system.

There is no remedy but to travel into Bernácer’s thoughts, although this excursion means a slight detour from analysing crisis. It will be worth it.

Bernácer’s work contained work done by Ricardo. One of them is when he spoke of land and mining exploitations throughout his work, or simply low-quality or unusual businesses. Here is where the idea arose of the rental of land or mining deposits of the best quality, second best, etc. These arguments stated that price increases caused by speculation is what made people cultivate and work low-quality lands. And this speculation is what makes incomes appear where they didn’t exist before. This is similar to David Ricardo when Ricardo stated that ‘income from the land is a cause and not a consequence of price’.

Bernácer surely took Ricardo’s ideas and related them to Turgot’s monetary ideas. Bernácer had a lucid and intelligent ability to relate ideas, making the birth of macroeconomics possible.

17.3.2. Critical period

This is a short and violent period. Time is dense with events that are quick and harmful. ‘Cash assets’ –liquid savings– become scarce and interest goes up, so that these assets don’t reach industry, industry that is on the brink of crisis. Some obtain expensive loans that they cannot repay, others don’t even apply for loans and some request loans that are turned down. Factories close, employees are fired and central banks increase the discount rate, although the amount of ready cash is not scarce. Bernácer made constant reference to the 1907 crisis during which even large banks suspended payments and the US had to import 600 million dollars of gold from Europe (which had a lot of money). Bernácer did not say that when banks go bankrupt, the bridge between savings and investment is broken, making the movement of now-scarce savings to investment even more precarious.

Many credit operations were carried out during the period of prosperity and there will not be money to pay them back. There is a desperate need for the concession of new loans, but unfortunately this does not happen. Then the young accountant made a prodigious comment foreboding any modern explanation of crisis. He said that in this sharp phase, there is logically an increase in the amount of lands and credits that need to be sold. Assets should be read as financial assets (I repeat that this explanation was from 1916). But as there are few cash assets or savings, there are large supplies and little demand for these assets, which contributes to interest or capitalisation rates dropping. Two points to remember: firstly, at this time Bernácer had already explained interest as the percent profit of the ‘assets’ placed in fixed-income assets. It is also the marginal or percentage return. Secondly, these assets are acquired with what remains after having demanded consumer and capital goods. In other words, with the part of savings that were not capitalised. And total savings, as mentioned, is scarce, so that there is nothing left for capitalisation or speculation.

Bernácer clearly stated that the vertiginous drop of the speculative market occurs. At the risk of being repetitive, these words from 1916 were prophetic, anticipating the famous Black Tuesday from that fateful October in 1929 on Wall Street that was the start of ten years of extraordinarily serious economic crisis.

Period of revival

The paralysing of industry, he said, is a powerful remedy to cure the evils caused by its overexcitement. Crisis firstly affected the end sellers, or merchants. Then it affected producers. During this period, merchants liquidated their products with difficulty and slowly started to recover the cash assets placed into them. These partly-recovered savings are not immediately returned via the purchase of new products, since demand is not requesting them. If before the ‘assets’ (savings) were intensely applied to industry in favour of low interest and then in favour of large demand, now those barely recovered by sales are not replaced. And they are not replaced because part of savings is materialised in merchandise and the other part resulting from sales is not destined for the acquisition of new products (merchants) but to pay back former loans. This is how the merchant sector, the first to suffer the risks of crisis, is the first to pull out of crisis.

The industrial crisis is the last to recover since, as stated, merchants’ liquid assets are not allocated to demanding the products that were so tough to sell. However, disposable funds or liquid assets continue to be gestated due to merchant sales. And these disposable funds allow channelling towards investment.

The same prosperity that made basic commodities go up brings crisis with it and this entails a drop in prices, making these basic commodities also decrease in price and becoming affordable for the population in need.

The interest rate, which had gone up, like the discount rate, blocks the free ‘assets’ left, which are normally replaced by the normal functioning of production. Then the assets return to industry via loans and are also allocated to demanding lands and other income assets, thus re-establishing their price.

The activity of this available ‘asset’ is double, since when some goes to loans to be lent, the means that merchant and industrial activities are attractive and also means that interest is low. But, in order for interest to be low, the increase of income-asset prices must reduce the interest on the financial market. With the production engine running again, idle hands will once again be occupied and economic activity will be revived.

Everything returns to the initial state, but Bernácer was not only pessimistic, he also believed in the fate of economic cycles. ‘Prosperity seems to come again, but deceitfully, since it hides preparations for favourable circumstances of the next crisis…’ (Society and Happiness, page 253). Next is the theme of war as a forceful engine feeding the economic system with its energy. This issue would return at the end of his life, after the world had read Keynes’ tax policy and after the Second World War. When Bernácer published Society and Happiness, the First World War had already been unleashed. It is logical that such an important event utilising so much energy would be handled by a macroeconomist who speaks of the pressures of real and monetary economies, etc.

Wars, he wrote, prevent the crises that were threatening to erupt. They make excess arms and mouths disappear. He did not explain if this disappearance is due to the productive employment of the system that provides them with work and food or simply because war kills people. War eliminates surplus economic energies, which are those that speed up crisis due to the lack of free expansion. War creates an intense demand for industrial products, so that instead of ‘assets’ being applied to capital to increase production, they are used to demand products with a secure outlet, as they are bought by the government. Bernácer’s last statement is not that consistent. The following phrase is the end of a very odd reasoning process:

‘This does not prove that war is advantageous, but that our social state is worse than war: its effects are more disastrous’ (Society…, page 253).

This was Bernácer’s pioneering explanation about crisis. Its design was created six years before his monetary theory and nine years before his theory on interest. It suffers from a certain vagueness and lack of scientific exactitude in its expression, but it is very useful as a frame of reference. His ‘modern’ analysis of crisis will be presented hereafter. His works on money and interest from the twenties played an important role.

17.4. Equilibrium

Basically, economic equilibrium is a dynamic equilibrium, even though the starting point is a simple idea: considering production income and production as flows that run through the economic body. And also due to the continual creation and destruction of wealth, the latter through consumption and the death by instalment of capital goods via functional depreciation. And lastly due to the appearance of opposing generating and destructing movements of wealth on the ordinary and financial markets respectively.

According to the body of thought set forth until now, equilibrium exists simultaneously with the following partial equilibriums:

1) There must be microeconomic equilibrium derived from the partial equilibrium of each product on the market. As a result of previous equilibrium, there will be overall equilibrium in the overall supply and demand for national product.

Since the demand for goods is a supply of money and the supply of goods is a demand for money, previous equilibrium will involve equilibrium between the supply and demand of money.

2) Wages and payments in different professions must be in proportion to their effort and risk. In general, this will occur with the profits of businesses that share opportunity, labour and risk in satisfying social needs; this occupation is a pretext for the satisfaction of suppliers’ needs.

3) Closely related to point 2. Interest rates in the different markets must be proportional to the yields and forecasts of financiers (which will entail maintaining proportion according to the assumed risk). If this does not happen, disequilibrium will be imposed via dynamic movement of the placement of savings, judged unfavourable in pursuit of more lucrative ones (I will now use the term savings again and not ‘assets’).

These movements in the system also put a mechanism into action that, after disequilibrium occurs, make it return to equilibrium, which Bernácer called automatic regulators. Even though this name is used by Public Finance and the Treasury Dept., here it has a slightly different meaning.

The rise and fall of prices and costs

If demand increases more than production, prices will increase. Demand, in turn, can only increase if the circulatory medium or money does so. If prices increase more quickly than circulation costs, profits increase. Since costs are production agent incomes, lesser proportional demand is produced (not absolute) for consumer goods towards others, where the others are the recipients of non-fixed income, that is the capitalists who have seen profits increase.

where C is cost increase, P is price increase and B is profit increase.

So that the market does not end up in disequilibrium, variable incomes must be saved and reinvested in production activities. This is the only way that lesser demand for proportional consumption is compensated by larger investment. Bernácer stated, in my opinion mistakenly, ‘that lower demand for consumption should be balanced out’. It is not a lower demand for consumption in reality, but rather a lesser growth rate of the demand for consumption, below the profit growth rate.

Bernácer demands a second requirement. This requirement, set forth hereafter, is vitally important and its simple explanation does not hide its enormous complexity. He said that depressive effects in the economy will come both due to not investing obtained profits (which I already explained) and due to investing them in working capital. I apologise if I repeat myself. The statement that all investment in working capital is depressive in itself is a constant in Bernácer’s work (speaking of investment and not of disinvestment).

Remember (and I repeat) that Bernácer wrote: ‘…equilibrium is only possible when an increase (or decrease) in working capital corresponds to an equivalent variation in the amount of circulating currency’; a result that, in its simplicity, has great importance in interpreting economic events. There is no doubt about the solid logical structure of Bernácer’s thought ⁷⁶.

I will briefly explain this statement. The act of investing in working capital, an operation done in this case via savings, means acquiring working capital assets that are removed from the market and return immediately after the production period. This is the most important statement in this work, the reason why I want to repeat it in other words. Investment in working capital is depressive because it entails adding new production to the system that is not accompanied by new income or, thus, demand, given that savings, that helped this operation, represented an absence of demand at that time. Conversely, investment in real capital means removing a capital good from the market, relieving the first and helping production. This is because the entrepreneur buys it with his savings, removing it from supply and taking it to his production facilities ⁷⁷.

If savings is invested in working capital, it is definitely not demanding fixed capital, with it remaining as supply gravitating over the market, while new product is being added to overall supply: product from production activity possible due to the application of working capital.

The creation of money remains as the only solution. How much? As much as the amount of working capital.

If savings is invested into fixed capital, owing to the greater profits considered, production activity detours proportionally towards the production industries of capital goods (proportionally less in consumer goods), with the result that no crisis will be generated.

Raw production materials

There is not equal production elasticity between finished products and the raw materials used to create them. End goods have a relatively short production period compared to raw materials, whose period is longer. And it is also true that the demand for raw materials is conditioned by demand for end products.

For this reason, booms or crises in the demand for end products quickly cause tensions in the demand for raw materials. Food products, land, raw materials and minerals require a long development period, at least much longer than the products that are created with them.

Primary and end product markets are united and complementary brothers and a boom in one will entail a boom in the other, the same thing that occurs during crisis. It is possible that during booms, since the reaction of raw materials is less elastic, their short-term demand will be greater than their supply, thus generating the seeds of prosperity, since prices will increase faster than costs, helping in the self-financing of new production activities.

17.4.1. Demand and the price of land

Land is an asset, indeed the oldest one, and it generates income. However, this income is a differential income. It is Ricardo’s income. How does it come about? There comes a time when income tends to decrease for unproductive, occupied lands. If you want to occupy plots of land that are not very productive or marginal, product prices must be raised so that these marginal lands earn income. In turn, these higher prices will make the rent go up on older lands already producing income. Thus, the high price of agricultural products is the cause of the generation of incomes and not the opposite. This means that land rents are not guilty for the high price of agricultural products. And along with land, one can speak of other natural elements like mines, fishing, etc. This will make people exploit mines located in places that are difficult to access and fish in far off places. The cause is the higher prices that make high differential margins be generated, which provokes exploitation of formerly marginal activities. If this increase is caused by speculation, when it finishes these marginal activities will be outside of the market.

17.5. LAND

If all lands were equal in quantity and quality, even if they were private property, landowners could not charge rent for them (an income). The reason is that competition between lands would reduce the rents charged until they were insignificant. However, since all lands are not equal, neither their quantity nor their location nor their quality, the landowner of the best ones obviously will have a relative monopoly on his lands, obtaining higher income margins than the landowner of lands in a worse location, for example. The work and capital applied to them will obtain higher returns on the better land than on the worse land; a proposition that can be combined with the Law of Diminishing Returns set forth by Turgot and by Ricardo with different examples and different styles.

Business premises with a specific construction will yield more in the centre of a large city than in the suburbs. If the construction cost is equal, the higher rent will go to the landowner of the plot of land occupied. What part goes to the landowner and what part goes to the producer? The first benefits from the difference between the yield of his land and the yields of the land of lower quality. This is differential or Ricardian income. The producer ends up with the yield of the lower quality land.

‘Land incomes’, stated Bernácer in a Free Market Economy… page 107, ‘hold a very special place among all distributive incomes; its effect tends to equalise the liquid profitability of labour and capital everywhere, absorbing the surplus of more favourable opportunities by way of the property right of which the landowner has usufruct.’

Caution is required at this point since if the land effectively generates free income for its owners, land, like plots, urban properties in city centres, etc. also produce a product. In the case of land, agricultural products; in flats, housing services or business operations, etc.

Let’s think about this point. Since the beginning, Bernácer always said that given that ‘assets’ (or savings) are susceptible to being placed so that free income is generated, that is where they will be placed. The ratio of income R to the market price of assets (land, properties, etc.), which is V, determines the interest rate i = R/V (where R is non-production income). Then interest is born outside of production activity. But if productive land and properties are also considered, which is an undeniable reality, given that macroeconomics correctly devotes an important chapter to property investment; Bernácer’s statement was unfounded with respect to actual assets on the financial market.

Far from placing these assets on the financial market, they should be placed on the ordinary market and, furthermore, elbow-to-elbow with capital goods. And in the same way that I have spoken of the marginal profitability and productivity of capital, profitability can also be correctly spoken of with respect to the lands occupied by businesses, properties and houses, which is also diminishing. Bernácer though was right about a very important issue. These assets are susceptible to speculation, occupying a monetary mass much greater than the value of the property or actual asset for these means. This monetary mass is savings that is taken away from production.

Note: This section may have been more appropriate in the chapter on interest. However, in the framework of the theory on crisis, it acquires great importance and this is due to the relationship existing between marginal returns and price increases, making these returns increase. Macroeconomics tells us that when the real profit rate is calculated for shares and assets, generally the dividends (and incomes) are calculated plus the capital gains and then they are related to the purchase price. The inflation rate is subtracted from this figure with the aim of estimating the real yield of said investment. Capital gains are the increases in the value of assets.

This formula was not set forth by Bernácer, but is rather from a modern macroeconomics text. If we only consider dividends, we find financial interest that Bernácer did not think was financial. But if looking at capital gains (increase in asset values), then it is indeed financial interest. Given that I am dealing jointly with mere income easily earned in capital gains or speculative gains due to the risk factor, I believe that Bernácer’s idea is justified, if it is assumed that capital gains would be the surplus obtained above the updated value of the production process services.

Given that these speculative earnings have involved actual marginal assets (land, houses, etc.), a drop in these earnings will not mean only the evaporation of these earnings but, like an avalanche, will drag a multitude of marginal companies with it, a cause pushing towards crisis ⁷⁸.

17.6. Unemployment

Unemployment is the most unpleasant human and social manifestation accompanying crisis. It basically represents the absence of production income in the working population and, secondarily, the absence of purchasing power.

The job market is regulated, like any merchandise, by its supply and demand, but unlike the normal or current market, the supply of jobs is the most intense supply, since employees need them to survive. It is also true that it is regulated by union actions that make job wages inflexible downwards.

Bernácer proposed freedom in the job market as a regulatory mechanism, absent from state regulators and inflexible unions. He said that true equilibrium is produced when everyone who wants work is free to find it at the wages they feel are suitable. If those who want to work cannot find a post due to state or union regulators, there cannot be social peace or equilibrium. There will not be peace given that misery is the breeding ground of conflicts and equilibrium will not occur because the misery of the working class means impoverished demand that accumulates forces towards disequilibrium.

Bernácer seriously criticised Keynes when he wrote: ‘Keynes introduced the notion of equilibrium with forced unemployment in economic theory; a notion that contradicts common sense because the existence of unemployment is the most pronounced symptom of disequilibrium…’ (A Free Market Economy…, page 108).

17.6.1. Underconsumption and unemployment

Work is always necessary. People work to produce consumer goods and also capital goods. The latter is the true social duty of society. Capital is nothing but accumulated work. If this statement is clear, why is it difficult to explain the origin of unemployment, since it is also a frequent and common event?

Bernácer referred to Malthus in 1955 in A Free Market Economy, referring to his first book from 1916. Lack of natural resources prevents people from working and being able to stock up on the means necessary for survival. They uselessly offer to work for this reason. Referring to Malthus, Bernácer then said that the solution to the problem is not found anywhere and, naturally, not in charity. Then he put forth his eternal argument about the weakness of actual demand. Before continuing, I will say that the young Bernácer (33 years old in 1916) glimpsed effective demand in Malthus’ work. However, he did not discover such an important concept in the Englishman’s work. This honour belongs to Keynes who, like Malthus, worked at Cambridge.

What happens, he said, is that there are no buyers. Reduced demand prevents wastelands from being worked and prevents other survival goods from being produced. What is called overproduction is nothing but underconsumption. If needs exist, even more than the actual means to satisfy them, what is needed are the monetary means willing to placate them. Logically, this is not a natural impediment as classical economists believed, but artificial.

If the impediments were natural, the issue would be resolved by applying more work for the production of end consumer goods.

Above all, misery would be overcome by applying more energy and intelligence to the production of capital goods and in technological innovation. However, this investment activity (actual investment) requires monetary means that it does not find, leading to the paradox that the work required for its production is superfluous when it is most needed.

17.6.2. Progress and misery

Progress is directly related to technical progress. It must also be connected to increased needs of humanity that are increasingly more evolved. Bernácer said that technical progress for some has reduced the time needed for the work of manufacturing the product. This opinion is supported, he said, by the consideration of workers as a separate class that will supply goods to the rest of society. The technical or mechanical progress in question will make such a volume of slaves unnecessary, like mechanical traction made oxen and horses unnecessary.

In reality, one works for oneself, to satisfy personal needs. Two things can happen: one is that needs expand indefinitely, in which case man will have to work indefinitely the more technical progress there is. If, conversely, needs are not unlimited, man will make a change consisting of swapping work for free time.

He then made an analytical comparison that was common in his work between the non-monetary and monetary economy. A primitive man in a non-monetary economy who knows he doesn’t need to work more to cover his needs, but less, can do two things: work more or work less. In the latter case, he will do so by producing production goods or instruments that let him work even less in the future. This is logical and the opposite would be absurd.

The introduction of money, which is the second example, will not make the absurd logical. If production efficiency takes place so that production increases, companies will react in two possible ways: One would be to obtain the same production level with less work and the other would be to achieve more production with the same amount of labour.

In the first case, some workers will end up unemployed, which will generate supply pressure on the job market, with wages consequently dropping. Salary costs decrease and business profits increase and, with this initial prosperity, the reinvestment of undistributed profits will be stimulated. In the end, the fired workers will be replaced. At this point, a new situation is outlined. Consumers may like the lower production level and may also enjoy consuming the greater production volume that production efficiency has made possible.

In the first case, the products will not have an outlet and will stack up on shop shelves. Using current macroeconomic terminology that Bernácer rejected, there will be an unplanned inventory investment. Production will be reduced and the least efficient or marginal companies will be expelled from the market.

The crux of the argument is the following: if consumers really want to spend less, where will they allocate their excess (production) income? The destination may have greater profitability than if they allocated it to consumption, the cause of its reduction, or maybe they simply want to consume less. It doesn’t matter. If they employ this greater savings owing to less consumption to the formation of actual capital, employees in consumption industries will pass it to those in the capital industry and unemployment will not increase and there will be no reason for the start of crisis.

But if consumers do not want to invest (them or others) or consume more, it doesn’t make since that they will continue wanting to earn the same. What is rational is that they will work less to then earn less income and thus combine lower consumption and less capitalisation with more leisure time. The opposite would be irrational. It would have no psychological or economic or mathematical explanation.

The result that should take place consists of the reduction of the work week, which does not happen. Conversely, higher unemployment happens. This explanation of unemployment is what I wanted to set forth, which will contribute to detangling the knot of the issue.

17.7. The explanation

If prices drop, company profits will drop, and companies on the edge of profitability just above interest will close and employees will be unemployed. Unemployment is not explained if wages drop more quickly than costs, since profits would increase and with them the hiring of new employees.

In Marxist economics and especially before that in classical economics, the existence of a surplus value of prices over wages is eliminated on the free market.

Thus, disequilibrium can be caused by these differences in the growth rates of salaries and prices. There are three possibilities of differences:

1) The prices of end products and costs are maintained in the same proportion:
(+) | Δ P | = | ΔC | | – Δ P | = | – ΔC |

2) Prices of end products go up more or down less than costs:
| ΔP | < | Δ C | or | – Δ P | > | – Δ C | ( + ) P = prices

3) The prices of the end products go up less or down more than costs:
| ΔP | > | Δ C | or | – Δ P | <| – Δ C |

In the first case, the situation does not change. Remember that Bernácer always thought in relative terms. Like in physics, our kingdom is the kingdom of relativity. Bernácer the physicist thought in relative prices. Prices relative to what? The end goods related to the supplies. This is another way of analysing reality via macroeconomics. Prices are partly entrepreneurs’ income and costs are income from supplies. Seen in this way, Bernácer was interested in the relation between specific income and random income.

I said that in the first case, nothing changes. It is true that money is worth less in the first and is worth more in the second case, but in both cases it is neutral money like classical money.

In the second case, industrial activity is more advantageous as profits will generate a boom that is recycled, but only temporarily, owing to the fact that working class income decreases. The economy will have a natural restraint, as mentioned, due to lower consumption levels of the working class. The only way that the boom is maintained is for the recipients of random income, entrepreneurs, to reinvest their profits in actual capitalisations. In this way, undesired inventory investments owing to less consumption that initially generated unemployment will be balanced through higher demands for capital goods that will reabsorb this unemployment.

Equilibrium will come when entrepreneurs do not reinvest surplus earnings and place them into speculative activities. In this case, impoverished demand will become even more impoverished, bringing decreased profits for these same entrepreneurs.

In the third case, industry becomes less attractive to entrepreneurs and their profits tend to decrease. Nonetheless, in principle there is no reason for this situation to continue. Don’t forget that salary costs are incomes that are reinvested into demand. Moreover, the free play of supply and demand on the job market brings a decrease in wages with it, making it more attractive to hire workers. From this argument, one concludes that profits will not drop quickly and costs will not tend to go up indefinitely. Thus, if the market is flexible, equilibrium will be re-established. If workers increase their purchasing power in the first phase of the situation, they can also save at the same time as they increase consumption. Equilibrium will be reestablished if this savings is channelled towards investment.

17.8. The end of saving and unemployment

Savings of either employees or entrepreneurs represents unspent earnings. If it is savings from the first group, the entrepreneurs have stopped earning, since they haven’t sold their products; and if the savings is from the latter group, it means that employees have spent a lot. It is not logical to state that a lot must be saved, given that if the majority is consuming more, it means greater savings for the entrepreneurs. All of this argument is the first act of the function.

When savings is spent on buying capital goods, monetary flows return to the system and let wages and fixed labour incomes and random expenses remain and be preserved from extinction. If system savings leaves and does not return, the entire system remains with an amount of money. Therefore, it is increasingly less possible to generate income, both fixed and contingent. The only solution is that there is infinite flexibility in the economic system that permits infinite price and wage flexibility. If flexibility is infinite, it is possible to achieve equilibrium in full employment with a lesser amount of money. He stated that this phenomenon is possible for classical economists.

But this circumstance is not possible in Germán Bernácer’s economic world. Flexibility, especially with respect to wages, is not great but actually more rigid, owing to the existence of state and union intervention, which contributes to the fact that those who want to work at a specific salary don’t find work, even though it exists. It is unemployment.

The destination of savings that doesn’t return to investment has yet to be explained. This destination can technically be hoarding. This act, real and monetarily sterile, represents income withdrawing from permanent consumption. It is an aesthetically accrued disposable fund that does not demand anything.

Is hoarding possible even without inflation? It is possible but not logical. The reason is found in Bernácer’s well-known argument that states that given that there is an income market or speculative market or financial market; it is always possible to leave savings parked, so that in the worst case income is earned. The percent yield of each unit deposited in this market is interest. Given that it is possible to earn interest by buying a share or a bond and not leaving money under the mattress, hoarding turns into an irrational operation. Financial speculation, conversely, being irrational actually and from a macroeconomic perspective, is not irrational individually and monetarily.

What is most important about this preliminary analysis, the sketch of a crisis, consists of the argument that makes it possible for flows of savings born in the system to escape from it. In classical economics, equilibrium will be re-established at each stage owing to the infinite flexibility of prices and wages. However, in Bernácer’s economics this is not so, since the rigidity of the labour market structure makes it impossible for the market to cause a return to equilibrium by itself.

An additional argument could be added. This aspect is not well-defined in Bernácer’s macroeconomics, although he did hint at it. This fractioned and obscure presentation can be seen clearly by someone who has analysed the whole of his work.

I am referring to the absence of investment not due to hoarding or the financial market (axis of his argument) or price mobility.

In times of pre-crisis and during this period, the amount of money tends to not decrease, but despite this, savings does not take the road towards investment. I believe this is possible because it has happened frequently in the economic history of towns. When there is no monetary regulation, periods of economic panic are soon generated, alarm spreads and soon savers go to banks to withdraw their funds. Paradoxically, this is when the system most needs deposits to not be withdrawn, given that in this way monetary supply will not decrease and interest will not increase. This fund withdrawal entails very serious problems that end up pushing crisis along its road. The consequences will be:

1) Essentially, the bridge between savings and investment will be broken, so that there will be savings but no road to take it to investment.

2) Actual and not possible monetary supply will decrease. One issue to debate is that then everything would be dumped into consumption, which does not happen. Here the explanation is interrupted.

3) The possibility of banks creating money will be frustrated.

All three points can be explained, although the second less than the rest. Let’s develop point three.

According to the basic Bernacerian argument in the theory of disposable funds, in order for equilibrium to exist, working capital must be financed with new money and savings must be free to finance investment in fixed capital ⁷⁹.

If savings demands working capital, it will have the advantage of adding new production to the market, but it will remain unsold and fixed capitals will be manufactured. New supply produced by the investment in working capitals will require new demand financed with new money. When savings finances fixed capital, it has the enormous advantage that some volume is removed from the market, lightening it; the opposite of working capital, which adds it.

But the economic system, stated Bernácer, is unreachable in the task of creating money; a task that is executed by banks. During crisis, companies are fearful of acquiring fixed capitals that represent permanence in the production system and that crisis itself prevents. For a well-founded reason, accounting calls them immobilised (inmovilizado in Spanish). The most comfortable action is to invest in working capital and the most logical in macroeconomic terms would be to create money.

But if banks go bankrupt, this new money is not created. It is during this period when crisis starts to be seen, when the banks most need to create money and they don’t create it because they are starting to disappear. The result is that the crisis receives the damaging force of a lack of money.

18. The dynamic of crisis in the theory of disposable funds

18.1. Introduction

At this point, I have presented Bernácer’s thought on crises at two points. The first was his early outline of crisis (An Aetiology of Crisis) prior to his theory on disposable funds and interest. The second part was done years later, although he did not go into great detail, but rather executed an institutional analysis.

The present chapter will provide an overall explanation of crisis, in the context of the Bernácer’s total analysis. If his works from the early twenties are added to his work from 1916, you will have a very comprehensive understanding of cycles. Later, these ideas would be combined and, more importantly, incorporated into an overall explanation of the market. This synthesis would be set forth in Analysis of Demand and Synthesis of the Market (1933), The Theory of the Financial Market (1935), Currency and the Economic Cycle (1935), Monetary Theory and Market Equation (1941), The Fundamental Expression of the Value of Money (1942), etc.

The present chapter about the dynamic of crisis can supersede the reading of the previous ones. I will assume that by this point that readers have a decent understanding of the concepts of savings, investment, disposable funds, interest, consumption, etc. The advantage of this exposition consists of reaching an understanding of the true dynamic of monetary circulation. This is similar to how human beings came to understand blood circulation and the role of the heart after Servet’s explanation. This idea of circulation was a well-known fact in classical and Keynesian and present-day economics. They knew it via their own mistakes that there was a single circulation and only one valve in the heart. The ordinary market is the heart and blood-production or money-income-production is blood circulation. I know and believe with reasonable security that in light of scientific advances, there are actually two different circulation routes: one that takes oxygenated blood to the cells and the other that carries polluted blood to be discharged by the lungs. These flows are driven by two valves in the heart. This is how income is distributed: one on the ordinary market, making the growth and energy of the economic body possible and the other that is occupied by the financial body, trading in dead wealth. These impulses are generated by the differences in two forces: the profitability of the ordinary market and the profitability of the financial market, which are the two valves.

18.2. Cycles and the system

The suspicion about the existence of cycles, even formulated by heterodox economists, was not studied by economic scientists as an analytical focal point. We will look at the extensive panorama of classical economics. The chronic insistence of these events has forced economists to study it in depth.

For Bernácer, cycles were not an evil inherent to the liberal system, as Charles Marx would have said for example, but rather to the institutional system. The real existence of economic activities made possible by this system make economic equilibrium irreconcilable. Bernácer said: ‘After these elements move away, the system of economic freedom, which has been proven to be the most efficient in stimulating production and wellbeing, will also be the best way to introduce stability and, with it, distributive justice.

18.3. The fall

Bernácer’s crisis is exclusively explained by monetary motives. Whatever the state of the economy, income flows from production and it must return to production via demand. If it does not, the causes must be sought.

In principle, we know for sure that consumption temporarily returns income to the market and that savings removes it from the market temporarily. So the trail of savings must be followed in consumption and production units. Part of this savings is allocated to reserves; at companies these are undistributed earnings. The other part is transported to investment through the banking system. Another part is used for other business, such as financial speculation. In the case of companies, these undistributed earnings are kept in different forms in order to carry out replacement investment. These are sinking funds. In all these cases, operations are sometimes done directly, via net investments and replacement investments, and other times done indirectly. This is the case of entrepreneurs that accrue sinking funds comprised of financial investments (badly called investments) to maintain the desired equilibrium between liquidity and profitability. Several things can happen during its journey that can cause the water collected in the pitcher to be lost.

These comments explain the different destinations of savings. These aims or destinations are the following ⁸⁰:

1) Hoarding of most savings, which are fully disposable funds of savers

2) Disposable funds spent (no longer disposable funds) in financial market operations. Bernácer called these operations realisations (in the classification of neutral operations). Savings is earmarked here to financial market transactions. System disposable funds as a whole do not lose their status; they simply change hands.

3) Individuals and the state, with the former receiving higher incomes (wages) and the latter receiving higher taxes (higher taxes for higher incomes), pay back past loans to banks. Total credits decrease, as well as circulatory mass and bank reserves increase, ceteribus paribus.

4) Financing of working capital. This operation is as follows: by companies applying their undistributed earnings to increase period production, by replacing funds that were used to repay bank loans in past periods or, lastly, by collecting savings occupied in the money market –floating savings– issuing securities ⁸¹.

These activities will be divided into two groups. The first group is made up of points 1, 2 and 3 and the second group is 4. What happens with operations in the first group? When they flee to the financial market, savings has decreased the actual demand for current articles and the amount of money remains constant in the total system, just like disposable funds remain constant. I said that actual demand has decreased, but potential supply and demand increase (to the same degree that actual demand decreases). Potential supply includes articles to be sold whose output was impossible due to the escape of savings and potential demand (born from production) are the disposable funds that change hands in financial market operations ⁸².

Savings is a part of income from production that must return to demand current products (consumer and capital goods). This operation is often aided by documented loans, financial assets (shares, bonds, etc.). But if this savings is hoarded, like in the first case, it means there has been a hole punched in the pipeline of monetary circulation, an operation that is not at all in vain for savers. In the second case, savings has fled to the financial market, causing serious disequilibrium in the system, since this is also the market where interest arises. In the third case, it is not a dangerous long-term operation. Repaying loans to banks does not in itself represent anything harmful, since their aim is to lend savings. Banking is more than a transmission belt in the economy’s engine, making the force of savings return to the engine of the ordinary market. I say that it is more than a transmission belt because banks create money with the deposits they receive. Far from being harmful, as Bernácer confirmed, it is benign, since the more loans that the state and individuals return to banks, the more deposits the banks receive and the more money they will be able to subsequently lend again ⁸³. If bank reserves were to increase indefinitely, then monetary collapse would be immediate. But it would have to be shown that bank reserves, and not deposits, increased; which is only explicable by a highly-unlikely decision taken by private banks or legal regulations. Let’s look at the last case (second group), which is a very original Bernacerian version of crisis. As I have repeated many times, this is an explanation of crisis owing precisely to great demand. This demand is for working capital, or investment in all meanings of the word. It represents a purchase and a sale of working capital, which also directly generates an increase in national product. If it is an investment, it therefore entails income in the economic system and, despite everything, it is harmful. I repeat the argument using a very simple example of a tailor.

I will devote a section to setting forth the dynamic derived from the investment of savings in working capital. Group two, point four is included in the issue of ‘the fall’. Let’s look at the example.

‘A consumer who abstains from buying a suit due to thrift leaves the fabric in question in the warehouse and leaves the tailor without work who would have created the suit, but she keeps the money in her pocket that would have been spent on the suit.’ This statement corresponds to the first three points in group one. Money that is in her pocket or could be in the financial market (Why not?) is potential demand and the unsold suit is potential supply. Let’s continue with the example. ‘Whereas the tailor, who has saved fifty euros from his profits, refraining from buying, for example, tools of the trade, and employs this money in making a suit to sell, not only has left those tools in the stock of the industrialist that produces them, but has furthermore created a new product for the market. The fifty euros that has returned to circulation could buy the suit or the tools, but not both (the emphasis is mine). And increasing the stocks of suits that are for sale is not an incentive to buy, so that more are made up.’ Reformulating this example in more technical terms: When company savings buy working capital, an operation called investment in working capital, and place them in the factory, a fraction of national product is created (the suit). Furthermore, it injects or determines income measured by the investment made. However, this operation means that they have stopped demanding consumer goods (clearly), especially fixed capital. If fixed capital were demanded, income would have been added to the system and removed from market supply. The tailor didn’t buy tools and instead made a suit. What will inevitably happen on the market is that either the suit or the tailor’s tools will not be sold. If it is the latter, following Bernácer’s example, he has bought fabric, thread, electricity, etc. to make a new suit with the application of this working capital. The suit, already made and while unsold, continues to be working capital and this is possible because savings has financed it, resulting in an injection of income into the system, which can then buy the suit or the tools, but not both.

Is there a solution to this depressive vicious circle? Yes, and the answer is to create new money to finance working capital. If this happens, savings can easily demand fixed capital and thus guarantee economic growth and monetary equilibrium.

Does it happen? Yes, due to a benign casuistry in the system and the good practice of banks creating money. Moreover, the operation is good because when banks transfer savings to investment (savings that buys fixed capital), they simultaneously create money (which finances working capital). This may explain why crises are not more frequent.

18.4. The graphic representation of the flow of savings

Production, Q, generates income with a value y (production), where part of this income is allocated for consumption, y_c, and the other part to savings, y_s. If it is allocated for demanding fixed capital, it will be y_k, and if it demands working capital, it will be y_cc. Unsold production or inventory investment is called I_u. I created a series of graphs hereafter that will explain each of the previous cases (mine but representing Bernácer’s explanation). The first will express a theoretical situation of equilibrium and the rest depict disequilibrium. Each of the previous symbols will in turn have a sub-index that expresses the time or period in which the phenomena occur:

Equilibrium:

Production Q is executed in the period t giving rise to an income of y_t. Production Q_t is divided into two productions: Q_t.c which are consumer goods and Q_t.k which are capital goods. Period income t + 1 is spent and splits into two parts, one that demands consumer goods y_c+l,c, and the other, saved, demands capital goods, or y_t+1,k. Equilibrium is assured in this way. But not the economic growth required to increase working capital (capital goods in the production process are also working capital); new money is also needed ⁸⁴.

This graph expresses investment in working capital using period savings, which as we know is a cause of depression. With period production Q_t, income has been generated of Y_t. Part of it in the following period t + 1 has demanded consumer goods, which are Y _t+1,c and the other part has not demanded capital goods (part of this income, specifically Y _{t+ I} – Y _t+l,c, sprang from the production of capital goods). Since it hasn’t been demanded, there is an unwanted inventory investment I_u. With the income not spent on consumer goods Y _t+1.cc (Y _t+l.cc = Y _t+l – Y _t+l.c) working capital has been demanded Q_t+l,cc (therefore Y_t+l.cc = Q_t+l.cc) giving rise to new production, which is supplied and gravitates over the market, Q_t+1 and new income Y _t+l. System income can demand, if it likes, either Q_t+1 or Q_t,k, but obviously not both at the same time or even one after the other, because what happens simply is that Y_t+l < Q_t,k + Q_t+1.

As mentioned, the market will be balanced if new money finances working capital.

If Q_t+l =M

Y _t+l + M = Q _t,k + Q_t+1 Equilibrium

If working capital were financed with new money M (M = Q_t+1,cc = Q_t+l) savings could withdraw totally to the production of capital goods (Q_t,k = I_u) and, due to being unsold, they would accrue as inventory investment. Since I want to make sure this point is clear, so insistently repeated herein and so fragmented in Bernácer’s work, despite holding a central axis in his work, I will repeat his comments made in a strategic article for the complete understanding of this part of his thought. The article is entitled ‘The Financial System and Crisis’ (1956)⁸⁵.

In this article, he confirmed that all income is born from previous production. The authorities and common sense dictate that income equal to the value of the merchandise produced is born from production. It is obvious that if disequilibrium is generated –always by demand– it is because demand is distracted to another task. Financial speculation is one of them. Income that does not immediately demand consumer goods is savings and the real investment act of savings is called capitalisation. Capitalisation consists of paying for labour that creates capitals, which can be working or fixed. Bernácer stated that the majority of economists do not insist on this distinction, even though it is so important.

Savings represents the temporary absence of buying and, therefore, represents a volume of unsold products. If income is born from equivalent production, the act of consumer spending means withdrawal of production from the market. Market supply has been lightened to this degree. There is obviously still an unsold production volume, which will be equal to the value of savings made. If savings demands fixed capital, there will be no problem. If, conversely, this savings removes a production volume that is monetarily equal, lightening supply, then investment means the transfer of fixed capital from production warehouses to company workshops.

But if working capital is financed; if raw materials, wages, energy and other collaborations are bought, more merchandise will be produced that is subsequently for sale. Thus, the money invested in it becomes monetary income of factors of production, and new products equalling the value of this investment will appear on the market at the end of this production period. This paragraph ends by saying: ‘… so that we have two groups of merchandise for sale: what stopped being sold, due to carrying out savings operations and the new product made at the expense of invested savings, but only a single purchasing power. The market will be in disequilibrium; so that, supposing that all the money that buyers will have received in wages will be spent on purchases, there will still be a sum of merchandise that is unsold equal to the savings invested in financing working capital.’ This is from the article The Financial System and Crisis. Another comment appears in the appendix of A Free Market Economy…

‘What happens in the case of consumption, as readers know, is that due to the purchase of consumer articles, at the same time as producers’ funds are replaced, quantities are eliminated from the market equal to the value of the purchasing power in the hands of consumers and merchandise in possession of the producers, so that they remain enabled to produce and sell new quantities equivalent to those sold before. There is no reason whatsoever for the contraction of production or the contraction of workers…’

This book continues by stating that the same phenomenon described will occur when investment is made; but not when it is invested in working capital. Let’s look at what he wrote in later paragraphs.

‘Since what is saved and what is capitalised is not the same, if working capital is employed (my emphasis), products are not eliminated from the market, but rather new ones are provided. The execution of savings leaves the equivalency in merchandise unsold; its investment will give rise to the same quantity of new products and savings will disappear to become new income, which can acquire the new product or the old one, but not both, so that the market will be imbalanced in favour of supply…’ (page 305).

The graph below shows the depressive operation derived from financial market speculation.

From the income born from production in the following period t + 1, one part goes to consumer spending Y_t+l,c, and another part demands capital Q_t,k and the other part is disposable income Y_t+I,D, which goes to the financial market or to trade assets on this market. Owing to this, actual demand of both consumer goods and capital goods decreases; with these goods remaining in inventory investments I_u and that, in equilibrium with unemployment, will be equal to the amount that flows to demand financial assets. Two arrows can be seen; one downwards that goes towards the financial market and another upwards, with the first representing the disposable funds that are born on the ordinary market and go to the financial market, while the others take the inverse path. The quantity on the financial market is net disposable funds. The ebb and flow, travelling from the ordinary to financial market, causes tensions between interest and capitalisation, giving rise to the economic cycles. This traffic also originates due to alterations in liquidity preferences of economic agents.

Given the enormous importance of this issue, I do not want to leave it without definitively settling another aspect, which although already explained, is worth expanding upon. I am talking about net disposable funds. Without explaining net disposable funds on the financial market would be like stating that, if the economic system were an economic agent, the movement of non-capitalised savings (S – S_k = D) to the financial market would mean nothing but moving the saved money from your left pocket to your right. If someone buys secondary financial assets, part of this savings will be given to the seller, who could buy a machine with this amount. My argument would go up in smoke, as the savings in the left pocket and then moved to the right would be understood as going from the latter to capitalisation. Why this does not happen is the explanation of net disposable funds⁸⁶.

The financial market is where income assets (Bernácer’s name) are traded, financial assets and actual secondary financial assets (lands, credit rights, plots, etc.); noncapitalised savings enter and others leave. If those that enter are greater than those that exist, net disposable funds increase, but if more leave than enter, they decrease.

Income assets have great fecundity. Firstly, they are born from the same savings transfer operations and even from production activities. One example is shares and bonds and another is buildings. The oldest and most genuine is land. This task of financial procreation is helped by the herculean task from the public sector of creating public debt and similar securities. Thus, financial operations continually devour disposable funds to be able to sustain market prices.

Like the banking system, in its task of channelling savings towards investment, it is highly possible that the financial market also swallows the new money created.

There are also savings or disposable funds placed on the financial market with future aims of capitalisation that are temporarily speculative. These are company sinking funds and reserves or the non-distributed savings of production units. Therefore, there are continual sales operations of these assets on this market to obtain money with which to execute replacement investment operations. Individuals also participate in these operations who simply want to spend the savings placed on the financial market. They are operations of the output of disposable funds to the ordinary market. They are benign operations for the system. How else can net disposable funds be explained? Well, by explaining the economic operations that occupy money; it is obvious that they do not demand current production. Stated more simply: If income is born from previous production and this production is not demanded, production is frustrated. And if production is not demanded, it is because other things are demanded that entail profitability. Thus, Bernácer said:

‘How many monetary operations are done whose direct objective is not the purchase of current labour products!…’

Classical and neoclassical economists respond that, since money is not destroyed by these types of operations, it will continue circulating in the system and consequently, continues being suitable for buying what its owners want. Pay very close attention to this line of reasoning of the classical and neoclassical economists and to the answer given by Bernácer the physicist.

Bernácer said that this argument is engendered by a sophism and that all sophisms arise from leaving out reality. If reality is not taken into account, nothing real can be concluded. Reality is time and space, coordinates where human and physical operations take place.

Thus, disposable funds, the financial market, etc. take place in time and space. Let’s see the importance of this statement. How many times have analogies of economic events using physics formulas turned out to be wrong and how many times have they turned out to be right? This is a case where they were totally right. Let’s see why:

Time, he said, is characterised by specific inseparable qualities (at least for Newton). These are: duration, continuity, irreversibility. There is another, he went on to say:

‘It has no defined name that I know of, but is similar to the impenetrability of bodies. Two bodies cannot exist in the same space. Likewise, two actions cannot be done at the same time by the same body. This incompatibility of actions in time prevents money, which is employed in buying a house, from buying another house at the same time… ⁸⁷’

Effectively, if money is executing transactions on the financial market, money that is a net disposable fund, it is obvious that it cannot be trading in consumer and capital goods. This is more than clear. It can also be explained as follows: if net disposable funds are on the financial market, then they are not on the ordinary market at the same time. Of course, funds leaving the financial market to go to the ordinary market can buy goods on the latter market, of course, but always after. And the ordinary market can be depressed if, during this later period, bits of savings are broken off to go the financial market.

The help of net disposable funds is great because they indicate the quantity of disposable funds that are on the financial market at a given time, as an overall result of their inflow and outflow.

While it does not disappear due to paying a bank (and the bank doesn’t give it back) or lost in a shipwreck or burned in a fire, it is certain that money is in the hands of someone, he stated. But he concluded by saying that ‘whoever buys a house tomorrow can buy a car on another day or a debt instrument or make a sumptuary payment.’ He went on that ability does not mean action, and we must distinguish between potential and actual. Thus, if money is used to buy shares on the stock market, an equivalent amount of merchandise will remain unsold, (I_u), and continues weighing on the market, later causing a drop in prices. The only solution consists of the speculator later selling his security and buying unsold merchandise; or that now, when our subject speculates, someone does the opposite operation, selling securities and buying assets with this money. But these comments are only potential operations, a laboratory hypothesis that confronts the past act, which is the speculative operation done at time t (now) that left unsold merchandise (also now).

If a billiard ball at time t hits two other balls, both move, but that does not mean two different actions for our purposes, but rather one single action.

Bernácer, who was never an economics professor (and didn’t even have a degree in economics), was trained in accounting, which enabled him to deal with macroeconomics from where income is born, at companies. Bernácer gave physics and chemistry classes at the Business Studies School, as mentioned earlier. According to his students, he loved experimenting. He used everything in the mechanics of economic operations. I believe that one of his ideas was the amount of movement or the conservation of energy, except that in economics, production and money are created and destroyed. Specifically, money has a tendency to perpetuate itself; it is the multiplier of income. Let’s look at what Bernácer had to say about this point.

Bernácer stated that Keynes’ multiplier, formulated by Kahn, could be stopped and lose its impact, owing to the existence of leakages. For Bernácer, these must have been hoarding and financial speculation. This phenomenon is explained hereafter: If income expands and multiplies, new waves of income reach each sector, which are less than previous waves due to saving. If income tends to multiply and monetary flows escape to the financial market with each increment, obviously, sooner or later, this expansion will stop.

I will comment on the following graph that explains hoarding now.

The reasoning is the same as always. Income is born from previous production Q_t, and if part of this income is hoarded (not saved), it remains outside of the circular flow of income forever. I give little relevance to this event because it goes against Bernácer’s central argument that states: ‘it is not reasonable for a person to hoard (or even invests) if he can obtain easy profitability on the financial market, earning at least interest’. The income originated is Y_t and after hoarding is Y_t+l. It will obviously be less than the initial amount (Y_t+1 < Y_t). If the production from which income was born was Q_t = Y_t, obviously this income will be incapable of removing production from the market, giving rise to inventory investments or stock. Then:

Summary

I will continue from section 18.2 ‘Cycles and the System’, corresponding to the typical handling of cycles in the context of the theory of disposable funds. Since for Bernácer, cycles are explained by the destinations given to savings or, if you like, the destination given to income born from previous production, this is why I will have four sections here that each explains a specific destination of savings. These destinations separately explain crisis.

After each destination is explained in the four following sections, he gave an economic version, accompanied by a graph, of their circulatory process. The cycle will be explained in this order: Depression, recovery, the road to prosperity and the inevitable fall.

Depression

The causes of depression must be sought in disposable funds and the savings from which they were born. Enough savings must be generated for net investment and replacement investment to be financed. The savings that makes this financing possible comes partly from companies and partly from individuals. Company savings is called reserves and sinking funds (although reserves have different statutory purposes and different theories). Individual savings is the part of income not spent on consumer goods. Both savings will finance investment, although this operation has the following drawback:

The first is that companies obtain fewer profits because prices go up less than costs. This aspect, already looked at in section 17.7 The Explanation, part 3, explains how companies try to lower prices to sell their products. The normal thing in a system of economic freedom is that unemployed resources, especially labour, compete for placement, making wages drop. But lack of economic freedom prevents it, with this translating into wages decreasing but at a slower pace than prices.

The consequence is that profits drop, as well as the possibility of self-financing in investment. This line of reasoning gives us the framework within which depression operates, although it is not thorough or sufficient. Other elements help to explain it.

Job market rigidity, given a level of business resources, makes many workers remain unemployed. It can also be explained by saying that higher salaries of employed workers (higher in relative, not absolute, terms) are possible because others are unemployed. Total demand in the system decreases, which contributes to entrepreneurs’ earnings decreasing as well. Profits B, obtained from earnings minus costs, are diminished since earnings are dropping more quickly than costs.

Many marginal companies are left out of the market and go bankrupt, dragging their employees into unemployment, another factor helping depression. I will leave the main argument for the end. Bernácer said:

‘It is not the size of savings that is the cause of depression and its persistence, but rather that capitalisation drops more. And this cannot disappear as long as production is not profitable…’

There can be sufficient savings and it can even, in my judgment, be aided by the creation of money, but as long as capitalisation (real investment) is less, crisis starts or, if it has already started, gets worse. If capitalisation is less than savings, then where is savings? This non-capitalised savings that I have called disposable funds is on the financial market, which also generates profits just like the ordinary market. The difference, and a very important one, is that on the financial market, profits are monetary and are real on the ordinary market.

The phenomenon of depression has different origins, but these origins are co-causal. Let me explain myself. Profits drop because earnings decrease more than costs. Earnings decrease partly due to the same initial unemployment but also partly because the financial market becomes comparatively more attractive than the ordinary one and system savings turn to that market instead of staying on the ordinary market. The situation intensifies because, on the one hand, savings is less than capitalisation, but moreover and due to this fleeing of income, savings becomes increasingly less. This savings, declining more every day, if transferred to speculation, deepens crisis more. The system becomes devoid of monetary resources, which brings with it a decrease in company earnings.

In Bernácer’s theory, interest is outside of production, even outside the market, and is due to the existence of the financial market, decreased profits mean that the marginal profitability of capital, or simply of the business, decreases. This is how companies drown that were not marginal before, but now are, simply because the marginal profitability of business drops below the interest rate. If interest drops, these companies will survive. Bernácer knew that financial speculation, fed by the flow of disposable funds, made the market price of securities go up, making interest drop (-Δi = R/ ΔV). But this process does not drive people to abandon financial activities, because another movement is simultaneously started. In effect, financial investors are not concerned about the percentage profitability or interest rate when speculative fever is taking place. Any speculator knows that the vertiginous rise of financial assets will be fully balanced out by the interest accrued in many years. This means that even if interest drops, disposable funds will not stop being injected into the financial market for this reason. These funds are the same ones that are not being employed in company capitalisation.

And if company profitability drops, this descent is helped by the fleeing of disposable funds that prevent capitalisation. The consequence is that profitability drops and financial market profitability drops (interest) although, despite everything, the second is greater than the first. The end result is that marginal companies that were not so before will disappear from the market.

Of course, monetary authorities can make interest decrease by creating abundant amounts of money. Nonetheless, the situation will change, as the motivation of economic agents is the key to the problem and the key to the solution. These agents simply seek monetary profitability and they find it on the financial market and not on the ordinary one. Thus, with this state of things, the creation of new money will quickly run to the financial market.

This last statement follows the sentence, already a cliché among economists, that ‘you can lead the horse to water but you can’t make it drink’ referring to investments that are inflexible to investment variations. It isn’t that investment is rigid, but that the other investment, wrongly called speculative investment, is extremely elastic.

The paradox of all this is that humanity stands thirsty around the fountain, as this period is when there is the greatest abundance of idle resources, equal to the idle monetary resources remaining. But they are not being hoarded; they are being used in speculation. This money must return to demanding consumer goods or capital goods (investment). Bernácer finished by saying: ‘…humankind suffers misery simply due to the paralysis of the circulatory mechanism…’ (A Free Market Economy, page 135).

Recovery

Profits can only increase after prices increase above the cost increase. If the economy is depressed, increased demand can only come from atypical expenses that force the collectivity to spend due to any outside event. The most frequent causes are wars, revolutions and calamities. Here Bernácer leant towards public sector intervention as an exceptional measure to end crisis. While he did not specifically propose public sector intervention, he did state that wars are the solution to crisis empirically and historically.

His words hereafter are very revealing. He said:

‘The only effective solution is to spend generously; the least important is whether this spending is useful or useless. What is important is that it is something where profitability is not measured, for example, on war and on weapons, where people spend without thinking about it, because it is a matter of life or death or national honour. Public works also fulfil the condition of distributing new income and their products are not on the market, although unfortunately the securities that have been used to finance them are…’

Let me clarify his comments, so that Bernácer does not seem like a Keynesian interventionist. The public sector is the largest treasury in the country, which is why state deficit causes an intense increase in demand that makes prices go up. Many economists state with naïve belief that unemployment will be resolved by the occurrence of deficit. The only thing that really happens is that prices increase, wherever spending is going: weapons, subsidies, public works, etc. This is the cause through which recovery is paradoxically linked to huge catastrophes like war, calamities such as crop losses, etc.

Another measure is outlined to resolve crisis, which is cost reduction. These can be connected to improvements in workplace organisation and also technical improvements. With respect to technical improvements, there is a problem which is that they require the concurrence of savings, which when applied, translate into new system income. However, by definition, if the country is in depression, these savings will be on the financial market.

Nonetheless, it could happen that huge prospects in savings of vehicle construction have stimulated the skills of technicians, geniuses and industrialists, leading them to take efforts to remove resources from the financial market and take it to capitalisation. They are inventions induced by two types of need: one, the need of industrialists to get out of crisis and two, the needs of a more demanding population. There could also be spontaneous technological discoveries that spread excitement to others. This is what public finances explains (not Bernácer) as economies external to production.

Now, these events would explain recovery if they were fatal and inevitable and natural derivations of economic circulation. But this is not true, since they are incidental and sporadic, the reason why depressions are irregular with regard to their duration.

For Bernácer, the two causes of recovery are on the one hand, intensive public sector spending, which stimulates demand and price increases. On the other hand, cost decreases due to the discovery of new technological innovations. Both are fortuitous. If both are mere chance, especially the first, this means that fiscal policy does not exist. Fiscal policy, sacred to Keynes, consists of deliberate action by the public sector, which manages taxes, expenses and public debt, to obtain the desired aims. An economic act is not politically necessary if not previously planned, and what is planned and what is chance (wars and calamities) are incompatible.

If Bernácer knew that public spending either on war or on subsidies or on public works, which is financed with new money, resolves situations of depression, then why wasn’t he a supporter of expansive fiscal policy? And it is not explained if remembering his idea that a drop in interest rates does not necessarily incite investment. Bernácer’s and Keynes’ macroeconomic theories are similar in some aspects that can be summarised in a single point. Crisis is determined by a drop in investment. Since the system is helpless to increase it, as Bernácer stated, then there is no solution other than expansive fiscal policy. Monetary policy is not effective and neither is fiscal policy. What solution did he propose then? Well, the absence of the financial market. A utopia.

Bernácer, deep down –and almost contradictorily– believed in the advantages of the free market. He defended this freedom by warning against the dangers of Keynesian interventionist theory. I will repeat his criticism, obviously stated after 1936:

‘Policies praised by Keynesian supporters would lead to monetary turmoil and if private capitalisation were replaced by public, which would establish a strong inclination of the state towards capitalism, that is a regime like Russian communism (words from his last book, A Free Market Economy…, page 308…).

The road to prosperity

Both the road from depression to prosperity and the road from prosperity to depression requires the concurrence of two facts. One will be the difference in growth or decrease rates between prices and costs and the other will be the movement of disposable funds from the ordinary market to the financial market and vice-versa. One pushes the other, but which one is first?

I would say that whether the state promotes demand or there is an invention or technological innovation, as soon as demand exceeds production, it will tend to stimulate it. Prices will tend to increase, except in those productions where prices have dropped so much that it is possible to increase production without costs and prices increasing. If, on the other hand, production during depression has decreased greatly, then it is possible to produce a lot, taking into account the quantity of unoccupied factors. It seems like Bernácer explained issues similar to the elasticity of production. It is even possible that monopolistic institutions are overwhelmed by factors of supplying, including labour, and prices of factors that translate into costs do not experience increases.

Greater profits, owing to the increase in prices over costs, make profitability from production activities increase. Here Bernácer did not blindly fantasise about the profitability of capital and preferred to speak of the profitability of general economic activity. This profitability can exceed that from the financial market and usurp it, where the disposable funds are legitimate that, in the end, have come from there.

Let’s stop for a moment to analyse two probable events during depression. According to Bernácer’s explanations, crises demand that the financial market experiences a significant boom. What happens then? Two events can take place as mentioned, but not explained. One is that speculative activity deflates fleetingly and quickly. This fall means the instant disappearance of disposable funds. The other is that this doesn’t happen. But which event is more likely?

Let’s suppose that speculation only stops and that the financial market does not collapse. There are no expectations here about the increase in security market prices (which can be called capital gains). Nonetheless, security market prices have increased, which is equivalent to a decrease in interest rates. Then, even without prices increasing significantly and costs dropping on the ordinary market, previously marginal companies are no longer marginal and savings invested in production activity are better compensated for than in the speculative market. If supposing that prices increase more than costs under these circumstances (public sector spending and technological innovations), recovery will be faster because the difference between interest and capital profitability or, better even to say general production activity, becomes more pronounced.

If the financial market collapses, the following will happen: I have said that two events can happen on the financial market that respond to static or dynamic expectations of speculators. If speculation is not strong or doesn’t exist, then the interest rate for savings is the attraction. If speculation is intense and endures, then capital gains are what attract savings, even more than interest. In the first case, interest tends to remain constant and, in the second, it tends to drop. Despite this, the allure of the financial market is powerful ⁸⁸.

Let’s see why. If the market collapses or simply stops falling, it is losses (called capital losses) that make speculators fearful, who then remove savings from this market and place it into production activities. The drop in market prices will cause an increase in financial market interest, but this increase will obviously be completely neutralised by the fear of speculators watching their savings go up in smoke. Moreover, the movement of savings –disposable funds– from the financial market to the ordinary one to finance investment will cause ascending price increases that will contribute to increasing production activity profitability.

Bernácer said that accumulative phenomena that lead to prosperity or to depression have held no mystery for economists for some time.

He stated: ‘…Mystery is found on the road from depression to prosperity and, above all, from prosperity to depression’.

In my opinion, this mystery would be clarified much more quickly if economists –including Bernácer– had concerned themselves more with analysing the cycles in the financial market and not so much in the ordinary market. Specifically, great efforts should be spent on analysing financial market scarcity or saturation, which would be explained by the relation between the growth of financial assets and disposable funds.

Before continuing, I will summarise the ideas of yields or interest from speculation in the two situations: one is static without intense and continued security price increases and the other is quick with continuous increases.

Static: R/ ΔV = –Δi… Disposable funds exit towards the ordinary market and profitability on the ordinary market increases. Recovery starts.

Dynamic: R/V + (V – V)… V – V’ rapid increase in security market prices. Interest drops, but speculative earnings (V – V’) attract more disposable funds than the ordinary market. Depression starts.

Static: R/V = i, interest increases and disposable funds are attracted to the financial market. Depression could start.

Dynamic: R/V = – (V – V’)… (V – V’), negative sign or speculative losses. Disposable funds exit quickly towards the ordinary market, causing the collapse of the financial market and encouraging the recovery of the ordinary one.

There are many limitations to this statement. Indeed, if income multiplies, it would be interesting to know the proportions of income that go to both markets. If income dwindles, the proportion it contracts on both markets must be known.

What is most important of all is to find out why, when the financial market collapses, it also drags the ordinary market with it. Let me explain. The financial market, like any other, owes the rise of security market prices to the fact that there is always a monetary mass behind them. If these considerable disposable funds stop being exchanged for income-yielding assets or just financial assets, the market prices of these securities collapse and interest goes up. This is logical. But the explanation that is missing in Bernácer’s work and Keynes’ work and macroeconomics in general is about where these enormous masses of disposable funds have gone. Here it seems like what is logical is not true. It would be logical to say: ‘fleeing from the financial market after its collapse, they go to the ordinary market via investment.’ However, reality has proven that when the financial market crashes, these disposable funds, the net ones that have increased, go nowhere, with the consequence that the crisis deteriorates. One could always argue that these disposable funds can go to hoarding. But I doubt such anomalous behaviour from rational beings who can obtain profitability on the financial market. One could propose that after the financial market has crashed, these disposable funds are spent on consumer goods, but this event would involve the recovery of the ordinary market, which we know does not happen.

This is my explanation.

The inevitable fall

Prosperity would continue provided that disposable funds are capitalised, as well as the income arising from this capitalisation. Real idle resources are demanded with unspent monetary resources, a procedure I will call actual investment. This investment is new demand that feeds the market, entailing the creation of new income, which will be divided between greater consumption and greater savings.

Higher profitability of production activity attracts disposable funds from the financial market, causing a void that depresses market prices and makes interest rates rise.

Crises have been accompanied by (before or right after?) an increase in interest rates, often reaching unheard-of levels. The same thing happens with discount rates. The moment of crisis has arrived. There is a great thirst felt for disposable funds or, if you like, liquidity. Why? Because recourses have been excessively immobilised during times of prosperity, some of which are from self-financing and others that are external. Commitments acquired cannot be fulfilled because they were taken on during a period of prosperity. There is a time when people lack money, although there may even be excess money as a whole. The same prosperity has tried to recycle itself and this is when many resources have been reinvested, not only the absolute value but in greater proportions even than in times of normality. Furthermore, present treasury excesses (sinking funds and reserves) have been placed in financial assets.

Liquidity is missing and everybody wants liquidity. The thirst is calmed in the springs of the financial market, cashing in their securities, which fall, making interest rates rise⁸⁹. These grotesque falls are the most dramatic manifestation of crisis and are also at its epicentre.

Modern banking institutions have been organised to remedy this situation. On the one hand, the remedy is to prevent banking crises by supplying funds to banks that need them. With new money, banks will also acquire financial assets that will prevent security prices from falling. Crises are aided in their fall by an endless number of anonymous volunteers, where the most important are bank crises that helped lead savings to investment and also created money, and the rising interest induced by the fall of market prices.

In times of prosperity, there is more demand than supply. Owing to this same excess in demand, enormous profits have occurred, which have stimulated companies to increase working capital and buy new facilities which in turn make income and savings both increase. But a time arrives when the products resulting from these investments are placed on the market and the opposite phenomenon occurs. This is when supply dominates demand. The depressive nature of investment in working capital is joined to the distraction of profits not distributed in income-yielding activities; activities that involve decreased demand.

18.5. The physiology of crisis⁹⁰

For Bernácer, monetary circulation is different than the explanation given in economics manuals.

These economists tend to explain it as a monetary current opposite the circulation of goods and services, where financial institutions are inside the system, being used as a mere bridge between savings and investment. This is so deeply rooted that they don’t even add drawings in elementary textbooks. In these texts, financial institutions hold a position like an invisible osmotic membrane, which makes a liquid flow of money move through this membrane from one place to another.

The matter was very different for Bernácer. There are two monetary circulations. One is the monetary circulation derived from current production and from distributing production incomes, which return via consumption and investment. The other circulation is financial. Here nothing is produced or distributed. It is an aberrant and poisonous circulation that carries blood without oxygen. Disposable funds, which are the part of savings that don’t return to the ordinary market, go to the financial market, being exchanged for financial assets. Each asset generates profitability. The percentage profitability of the disposable funds placed in each asset is called interest.

There are thus two monetary circulations driven by two valves. One, the ordinary market, is productivity or marginal profitability of capital, and the other is interest. The trajectory of monetary blood can be invested with meaning due to the relative broadness or narrowness of the two valves. This investment explains the physiology of the cycles I am going to explain.

Income is born from production; this is the explanation given by Say. To understand the breach of this rule, you first have to understand how it works. Two currents are born from the bottom base. One is the production that goes up the left-hand column, which in turn splits into two sub-columns. One is the production of consumer goods and the other is the production of capital goods. Both should find two demands that absorb them (that they should does not mean that this actually happens).

Income is also born from the base that goes to the right-hand side, rising along the column. This income is spent, where the expense is demand. Demand is an exchange between money and goods. The right-hand column, where income rises, splits into two sub-columns. One –the inside column– is spending on consumer goods and the other is company and individual savings. Here is where a fateful subdivision takes place. Total savings should logically be absorbed by the production where it was born. Savings should be used to finance investment. But this does not happen, as a part of savings demands financial assets. Consequently, demand ends up being weakened.

According to my explanations, derived from analysing Bernácer’s graph, the so-called net disposable funds would occupy the internal circuit at the top of the graph (demand for financial assets = supply of financial assets).

In the outside left-hand column, the demand for capital articles absorbs the capital supply. In the inside right-hand column, the demand for consumer goods absorbs consumer goods⁹¹.

If, as mentioned, the demand for capital equipment is not enough to have split into two on the financial market, market depression will occur. This depression can be balanced out by a greater demand for consumer goods. Another possibility is that even though a large part of savings enters into financial circulation, part of the disposable funds leaves the disposable funds on the financial market to demand capital and/or consumer goods on the ordinary market. This explanation demands the participation of the net disposable funds that I already explained.

Thus, movements that are not necessarily cyclical but are disturbing can be explained. This is the case for demand that alternates demanding more consumer goods than capital goods or vice-versa. All operations that represent production being greater than demand will help in the formation of crisis. In this situation, the left-hand column of the graph would collapse, as in the case of savings that helps form working capital. Let’s look at what happens in this case. New production will rise in the form of supply on the left-hand side and a new current of income will ascend the right-hand column. The left-hand column is found awaiting a demand for capital goods. Thus, the current of spending on the right that was previously saved can now demand capital goods, in which case the new production from which it came will stop being demanded. It can also demand this new production (from which it was born), but in this case the capital goods would be unsold.

Crisis also starts when excessive investment on the ordinary market takes time to be recovered monetarily. Stated differently, excessive investment entailed greater demand than supply, but until new production, the fruit of this investment, recovers it, it is greater as supply than as demand, with the market thus collapsing, although only temporarily.

I compared the mechanism of monetary circulation to blood circulation pumped by two valves. Bernácer, as a physician, used the example of a hydraulic ram. He said: ‘In it (referring to the ram), when a current of water has a broad outlet, it starts acquiring speed and flows back forcefully, raising part of the water to a greater height, until the drive received ends; then the drainage valve opens naturally, the water flows out and acquires enough speed to determine a new hit from the ram…’ (A Free Market Economy… page 143). Bernácer had a hydraulic ram in his physics labs at the Business School, which he obtained after making many requests to academic authorities.

He continued:

‘In the event of the mechanism that we studied, what acted as a closure valve represents the financial market. When there is a spontaneous movement of growth in demand, the current of funds towards demand speeds up on its own and, after acquiring a certain speed, the emptying of disposable funds in the financial market plugs up the exit, making funds flow back towards this last market, with which product demand is deserted, which weakens until there is a new hit from the hydraulic ram.’

18.5.1. Boom and crisis

Prosperity and depression are different concepts than boom and crisis. In my understanding, these latter are temporary episodes within any general cyclical wave. Let’s look at what Bernácer said:

‘Boom is a sporadic accident of prosperity, like crisis relates to depression, although both can be left out or happen abortively: the first in a phase of depression and the second in a phase of prosperity, greater depending on the capitalisation process initiated under the stimulation of the rising movement. It often obtains a fortiori in the adverse situation due to contracts and commitments acquired earlier. This can cause the appearance of specific resurgence symptoms, to then later fall into the deepest stagnation…’ (A Free Market Economy…, page 143).

It seems like movement towards depression starts before crisis. It is not necessarily the inflection point between prosperity and depression. Crisis is a situation that involves the breaking of ‘something’ as the result of forces that were gestating. ‘Crises, like booms, are the result of discordant and poorly-regulated movements. If this discordance, with its effects accruing, ends up causing such large disequilibrium that the system’s elasticity is exceeded –despite the means in place to prevent its explosion– fissures appear here and there, until crisis is precipitated in the end’ (A Free Market Economy…, page 144). Booms and crises are thus periods that register accumulated situations of tension and whose explosion leads to movements towards prosperity or depression.

He added the mechanics of his financial market to these concepts. Thus he stated that the periods preceding crisis are characterised by the notable boom of the securities market, especially the most speculative ones: industrial securities, farmlands, plots and urban properties. These are words from 1955, 26 years after the Great Depression of 1929, which was marked by its significant speculative fever. These sentences were also stated in his first book from 1916, which referred to crises before that year obviously. The causes of this process are double: prosperity makes the prospects for these securities go up and makes it possible to obtain large profits. These profits do not derive from production activity, but from purely speculative and monetary actions. These greater profits are enormously attractive to floating savings and disposable funds (before potentially going to capitalisation). The other cause is that abundant earnings have encouraged the creation of abundant savings that travel towards the speculative market, attracted by the chance of obtaining big profits.

Savings, that increases, does not move towards the investment that demands it, but rather results in the creation of tensions of crisis and the road towards depression.

In the diagram of the genealogical tree of the History of Economic Thought, I would place Bernácer on the fertile monetary branch. His theory of disposable funds and its ramifications are also monetary. The outline of booms and crises has always existed. There are signs of its existence in ancient Egypt, Greece and Rome. What is a clear fact is that the invention of paper money, registered shares and fiduciary instruments has all fed cyclical processes. The maximum effect that money has on depression and prosperity are the phenomena of oscillatory movements and in reality when these movements have occurred, they have done so violently. As you will see, Bernácer thought that the gold standard was a golden pendulum causing cyclical movements instead of being a metal stabiliser that regulates the trajectory of the economy.

18.5.2. Gold

The physics professor at the Business Studies School knew that waves are propagated in certain mediums. If they are seismic, they will not propagate in a rigid medium (my example) and fractures occur. After the system is broken, there is innate flexibility in the system upwards towards prosperity or downwards towards depression.

He said: ‘One of the most rigid currency systems that has been invented is the gold standard, which ties currency to a specific value in monetary metal and maintains circulation with respect to the gold reserves it has (A Free Market Economy… page 14). The monetary problem referring to the metal standard established was handled by Bernácer in his first scientific articles (Currency and Social Issues, 1919; The Monetary Problem, 1921; Two Present Matters: The Laws of Banking and Customs Duties, 1921, Discourse on Changes, 1924, published in the Revista Nacional de Economía, Madrid), revealing his concern about this essential problem ⁹².

During those years, John Maynard Keynes had already gone into great depth on this issue. His book A Tract on Monetary Reform set forth his disagreement to the gold standard and showed him as a supporter of purely fiduciary currency. In 1913, he had already published a systematic study on the gold standard-exchange as a corollary of his experience at the India office from 1906-1908. I duplicate his famous sentence from this book: ‘In reality, the gold standard is already a barbaric reliquary…’, a sentence that was scandalous and explanatory. He would participate in the Bretton Woods conference that would give rise to the International Monetary Fund, with its participants involved in great preparation on international monetary themes, especially Keynes. Keynes’ project was defeated and with it the monetary stability of the world. I have no reference about Bernácer’s comments on that project, but I believe that he surely would have supported it. Keynes was firm about this issue.

I said that the physicist Bernácer placed cycles and system flexibility as opposing forces, and the gold standard is an excessively rigid monetary system. The gold standard is a very rigid technique and therefore pro-cyclical⁹³.

18.5.3. The gold standard and cycles

In addition to the institutional definition of the gold standard known by all, it is also characterised by two further qualities. Gold is a payment method on the one hand and on the other, this same payment method is in turn merchandise. As a payment method and a quantity, it is related to the general price level. As a commodity, it is liable to be kept and intensely supplied, competing with others in the general supply of products. This comment made, let’s see how different situations are related to each other. Hoarding of gold commodity causes monetary contraction and de-hoarding it causes monetary expansion. Both movements escape from monetary authorities and favour cycles. Let’s see how.

In principle, the gold standard system proves advantageous due to containing great value in little volume and under these conditions; it is possible to establish the value of currencies with respect to gold. Convertibility is an operation that makes the conversion of gold into current currency and vice-versa possible at a fixed rate. If gold becomes scarce with respect to currencies, the latter loses relative value and, if it becomes abundant again, they increase their value.

Due to this quality of the gold standard system, of convertibility, gold is the commodity that best lends itself to hoarding. Furthermore, if there are liquid capitals that find no profitable occupation, owing to depression for example, their best placement can be found in gold. The purchase of gold with liquid capital for hoarding is a much more attractive operation than the hoarding of current legal tender ⁹⁴.

Gold hoarding entails altering the current gold-currency ratio in favour of the first. Even though the quantity of currency in circulation does not change, it will abound more than gold. If gold is wanted, like any other commodity, due to being scarce and currency relatively abundant, the price of gold will tend to go up dramatically. And it is obvious that, since gold is a payment method whose value establishes the value of currency, the relative abundance of the latter with respect to the first causes a decrease in the currency value. Since gold is a commodity (I will repeat the same argument differently), its supplying is annulled, which makes its price increase and decrease in monetary terms according to demand, established by currency in circulation in the pockets of buyers ⁹⁵.

Since convertibility is done via a fixed or fixed rate ratio, as the gold price goes up due to its relative scarcity above all other commodities, this means the prices of the others will descend. General price decreases are imposed in the system, reducing the profitability of production activities. This is how the gold standard, or the basic quality of gold as the ideal element claimed by the system for its implementation, translates into danger. If depression didn’t exist, it can cause it and, if it already started, it can make it worsen. Gold causes the appearance of crisis.

And, what happens if individuals do not employ their liquid capitals and deposit them in banks, that is, if they don’t buy gold and don’t hoard it? The same thing happens. These liquid capitals are deposited in the bank, which when not finding clients or borrowers, like what happens in depression, they dispatch it to the central bank. Then the central bank has to reduce or increase circulation by buying gold that, besides commercial loans, is the only asset admitted. The relative or absolute increase of reserves produces the same effects as hoarding by individuals.

The immediate consequence is that currency devaluation is set into motion. And how is the public protected from currency devaluation? Well, by hoarding the gold still in the system. As you can see, the process is acquiring symptoms of depression. These are the consequences derived from the existence of the gold standard during depression or at the beginning of depression. Let’s see what happens during boom periods.

When large expenses are generated and the situation is on the rise, gold is un-hoarded and supplied on domestic and international markets and its price as a commodity drops. This drop means that the currency in circulation becomes relatively scarce with respect to gold, which becomes abundant, which hence means that the currency is worth more in terms of gold. In other words, the same quantity of currency can buy a larger quantity of gold commodity. Or one more time, since gold is more abundant than in previous periods, due to its de-hoarding (to finance greater boom-time expenses), its price drops with respect to other commodities, which means the prices of these other commodities increase. This is how the gold standard accentuates boom.

If the gold standard were established internationally, the rigidity of the monetary system would be internationalised, also favouring the worldwide propagation of cycles. To Bernácer, a large part of the continuity of the crisis in the 1930s and 40s arose from the gold standard and as the moorings were released from gold, the economy could climb out of depression.

18.6. The journey of cycles

Seismic waves flow from the epicentre outwards to the rest of the system. The ease of transmission is a function of the flexibility and permeability of the medium. Since each economic system has its own elasticity coefficient, the journey of cycles undergoes a wide range of different durations and intensities. Since sometimes there is a somewhat common state of rigidity in systems, like the gold standard, it is clear that cycles can have the same epicentre that sends waves out, minimally having the same propagating facility. This minimum will be given by the gold standard. On the other hand, international trade freedom is a common level of flexibility in the system, in the same way that lack of freedom indicates a level of rigidity that facilitates the propagation of cycles ⁹⁶.

Trade is the natural vehicle for cycle propagation. International trade thus propagates them among different countries. This line of reasoning is supported by two institutions: one is the monetary mechanism that gives rise to payments between two countries with different currencies and the other are institutions like customs and trade freedom. For example, the gold standard represents the most suitable instrument for the propagation of cycles.

Imagine that crisis starts in a country with relations with another country that is in a phase of prosperity. The country in crisis suffers a weakening in internal demand that has an impact both on the supply of domestic products as well as supply from foreign countries. Domestic suppliers try to sell unsold production at any cost. As a consequence of this effort, prices drop more than costs in the country in crisis, with business profits therefore suffering. But part of this supply is also released abroad at low prices and the prosperous country ignores part of its own demand to import products from the country in crisis. However, the prosperous country cannot sell its production to the country in crisis as it would like, due to the weakness of demand. The end result is that the prosperous country has supplies that have increased as much as imports on the one hand and on the other, because demand has left to buy cheaper products from the weak country.

The country in crisis received gold as payment for its exports and gold has left the prosperous country to pay for the imports. This is the argument given on the stabilising effects of the gold standard. However, several different things can happen during this process.

For example, the gold detainers in countries in crisis that have exported can hoard the gold, the same as the exporting country starts to have a scarcity of gold, which excites hoarding. In the first, hoarding can be attractive because domestic demand is weak and, as profitability of production activities decreases, emerging savings are dumped into getting and hoarding gold. Another possibility is that both countries seek recovery. One through exporting and the other because it tries to continue along the path of prosperity with the same intensity as before. Then, for this growth to continue, more gold lubricant is needed than what exists in the system. There is a war generated for the booty of gold through production weapons in international trade. It is a dirty or underhanded war that alters the real exchange relations in different ways. These means will be customs barriers, the existence of importation limits, monetary devaluations, etc.

I said that it was an underhanded war because no production efficiency is seen here, which are the legitimate weapons of competition. For example, a product is produced in which sophisticated technology has been applied, employees have worked earnestly, the best raw materials have been imported… resulting in laudable quality at a low price. However, trade shackles make it into an expensive product lacking interest. Competitive devaluations, high import taxes, which are the techniques for demanding gold –in modern days these will be foreign currencies– alter the normal and natural relationship of prices and, therefore, of the economic discourse. In the end, gold and foreign currencies have the same meaning as money, since they are money, and this meaning is buying or demand. In trade wars, countries see their chances to sell their products crippled, which means that the same international traffic in money is paralysed. It is clear that this paralysis provoked in the heart of the money market with trade aims will feed itself when end monetary stagnation takes place.

Countries accrue stock that they cannot sell; unemployment increases and, along with the tendency to export unsold products, there is also a tendency to export unemployment.

In this way, Bernácer tried to explain how a fixed exchange system, like the gold standard, is a suitable means for the international propagation of cycles. Along with gold, trade interventionism is an institutional means that easily and quickly drives the waves of the cycles in all directions.

Bernácer is an energetic defender of the free market, both in domestic and international economies. Thus, he said: ‘The most effective means for defending oneself would be to adopt independent circulation with variable exchanges, which would be an automatic compensator for drops in external prices, because the exchange fluctuations balance out price fluctuations’. Next, he attacked the patriotic superstition about supposedly unfit devaluation. He said: ‘… But there is a prevailing mythology about monetary depreciation as the most dangerous and threatening event to the domestic economy. And they have preferred to endure tough crises before suspending the gold standard and letting the exchange rate fall, or taking on serious debts and turning to all imaginable means to block trade, although these means turn out to be inefficient. When there is no other option, they have turned to state intervention for exchange rates, the most damaging choice for trade and the economy…’ These words show that Bernácer believed in free market economy of goods both domestically and internationally and, naturally, for money. Devaluation is a consequence of this monetary free market. The final sentence empirically shows his feeling about the issue: ‘And, nonetheless, it is a true fact that currencies without fixed exchange rates have proven to fluctuate less in their internal value than those subjected to this oppression’ (Bernácer’s quotes in this section are from A Free Market Economy…, pages 147-8).

18.7. Pessimism

There is no symmetry in cycles, as depression is vocational in the economy, while prosperity is sporadic. This was Bernácer’s field of thought about cycles. Depression can be long and deep. And, although depressed economies don’t sink any more, it is true that they can easily remain in an initial state of prostration. States of prosperity are events that are more sporadic and soon burst to make the system fall into a state of depression. Bernácer from 1955 did not clarify if this economy that he called depressed is significantly below full employment. If this is not achieved, the economy will not be depressed for this reason. Like illnesses, economic fluctuations are characterised by their difference with respect to full employment. A small stagnation is not the same as a depression like the one in the thirties.

Bernácer in 1955 revived specific philosophical-political ideas that appeared first in 1916, when he stated that wars place demand in a vigorous situation that is more than enough to obtain full employment. To him, humanity has wanted to rise out of misery through technical advances, but this effort has been futile, as these advances are applied to evil. He was talking about war. When peace returns, he said, the brakes on production activity are put into action. This purely pessimistic statement is useless scientifically and, moreover, it is wrong. Inventions made during peacetime are useful for creation and even more so due to their applications. After wars, a diverse series of technical advances are implemented that arise from wartime needs and emergencies. The fact is that these advances, wherever they were born, let the marginal efficiency of capital or the marginal rate of profits in production activity increase significantly, thus flooding the dam, with interest resisting the free circulation of savings.

Bernácer could see how after war in Western countries, there was important and real growth. Technology applied to production activities, which led to consumption of greater quality and quantity, made an increase possible of national incomes in real terms. Maybe this phenomenon could not be appreciated in an isolated Spain after a civil war, but it could in other countries like England, Germany and, above all, the United States. An educated man like Bernácer had to have known this.

There were also other important issues that conditioned cycles and their limitations. Along with technical advances was the distribution of incomes, an issue that Bernácer did not emphasise much. Reality and macroeconomic theory itself would have advised making his opinion more optimistic, which I believe should be as follows:

‘The economy is subjected to forces that distance it from full employment, even though it is still possible to achieve an economy that grows in waves in real terms, along a path that makes the increase of real incomes possible.’