Thursday, October 9, 2008

"Good Policies Can Save the Economy"

They've been let off the hook for a few days, but it's about time the Wall Street Journal received another squeak from the wheel. This one is about the return of the Federal Reserve to its original purpose (in a small way). As usual, we encourage you to write your own letters, whether to your local newspaper or to the Wall Street Journal. You don't have to include a CESJ donate button in your letter.

Dear Sir(s):

In "Good Policies Can Save the Economy" (WSJ, 10/08/08, A17), Lee E. Ohanian notes possibly the most significant policy change since the derailing of the Federal Reserve in 1917 to finance World War I. Unfortunately, he makes it sound as if the recent Fed decision to begin discounting short term qualified industrial, commercial, and agricultural paper, while necessary, constitutes a departure from the proper role of the central bank of the United States. On the contrary, the decision is a long-overdue return of the Federal Reserve to its original purpose: to provide the private sector with necessary credit and liquidity when the existing money supply proves inadequate.

Still, the decision, while a move in the right direction, is only a first step. It demonstrates that existing accumulations of savings are not necessary to finance capital formation, as Dr. Harold G. Moulton pointed out in his landmark 1935 study, The Formation of Capital. Countering the established dogmas of Keynesian economics, Dr. Moulton proved that the economic growth of the United States from 1830 to 1930 was financed not out of existing accumulations of savings, but by the expansion of self-liquidating bank credit.

Tax cuts, while no doubt welcome, are thus not necessary if the goal is to provide financing for new capital formation. Providing liquidity and credit for capital formation is the role of the Federal Reserve, which since 1917 has (contrary to the 1913 Act) largely been restricted to monetizing government deficits and providing financing for politically-determined objectives, e.g., financial institutions considered "too big to fail."

A program called Capital Homesteading for Every Citizen has been developed that would open up access to capital credit to every American for the purpose of purchasing self-liquidating assets. A first step toward establishing a national Capital Homesteading program would be the implementation of "Homeowners' Equity Corporations," or "HECs," a mechanism designed to solve the current home mortgage crisis and accelerate the return to an asset-backed currency, which the Federal Reserve's decision initiated.

HECs — like leveraged Employee Stock Ownership Plans ("ESOPs") — would obtain acquisition loans from commercial banks, which would charge a transaction fee for the service. The commercial banks would then discount the loans at the regional Federal Reserve bank, adding sorely-needed asset-backed liquidity to counter the credit crunch in local economies. Analogous to the "free" land under the Homestead Act of 1862, the Federal Reserve would provide "free" credit, with the discount rate set to reflect only transaction costs and a revised risk premium, thereby creating currency backed by income-producing assets. The homes could then be leased to their former owners or new tenants at a monthly payment sufficient to cover debt service, maintenance, taxes, and administrative costs. Tenants would earn shares in the HEC as lease payments were made. When a loan was fully paid, the tenant could exchange the HEC shares for title, or continue as a tenant/shareholder at a reduced lease payment, sufficient to cover costs.

Yes, we need good policies — but we have to make certain that they are the right good policies.

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