Wednesday, December 10, 2008

Increase Consumer Income and Stimulate Economic Growth

Here is today's blast to the Wall Street Journal. It is becoming more evident every day that few people realize the difference between good credit (credit used to finance self-liquidating capital projects) and bad credit (credit used for consumption, speculation, and government spending). Even worse, the predominant economic theory holding the world in thrall today is that of Lord Keynes ... who appears to have had a very tenuous grasp (if any) on money, credit, and banking, despite the involved and confusing explanations in his General Theory.

Mr. Harvey Golub's op-ed piece in yesterday's Wall Street Journal ("Getting Out of the Credit Mess," WSJ, 12/09/08, A17) provides a necessary wakeup call to those who still mistakenly believe in the Keynesian dogma that the State can spend the country out of recession and depression. He is absolutely correct that credit — when it is used at all — must be used for sound, financially feasible loans that carry a reasonable expectation of repayment. Mr. Golub is also correct that only increasing consumer earning power through economic growth and decreasing (ideally eliminating) loans made for projects that do not generate their own repayment or are insufficiently collateralized with existing hard assets will bring us out of the current crisis.

We would add that, consistent with the findings of Dr. Harold Moulton in his iconoclastic monograph The Formation of Capital (1935) and the work of Dr. Louis O. Kelso and Dr. Mortimer J. Adler in The Capitalist Manifesto (1958) and The New Capitalists (1961), we cannot limit our understanding of "consumer earning power" solely to the ability to sell labor for wages. We must add in the natural right that each human person has to own productive assets — capital — and derive an income therefrom. If, in accordance with sound central banking theory we use the commercial banking system and the central bank to create money exclusively to finance capital formation, and stop money creation for consumer purchases, speculation, and government spending, there is no need to divert capital incomes (dividends and capital gains) from consumption to reinvestment. If all newly-formed capital is owned by people who finance its acquisition with such "new money," and who use both their labor incomes and capital incomes for consumption, dramatically increasing consumption, the economic growth that we need to get out of debt will occur.

The only issue that remains is how to initiate the process of capital formation so that people who currently own little or nothing in the way of income-generating assets will have something to purchase with the credit extended for such purposes. As Dr. Moulton demonstrated in 1935, the demand for capital is derived from consumer demand; typically before periods of intense capital formation, there is an upswing in consumer demand. This increase in consumer demand depletes savings, leaving little or nothing left to finance the formation of capital, hence the need to use the banking system to create money for that purpose.

The problem today is that savings have already been depleted and enormous debt incurred, not for the legitimate purpose of capital formation, but for consumption, speculation, and government spending. This has severely curtailed the lending capacity of financial institutions, while the central bank is busily following standard Keynesian dogma by creating ever-increasing amounts of money for consumption, speculation, and government spending — a classic case of trying to get out of a hole by digging it deeper.

The solution to this conundrum is the concept of financial feasibility. Typically a business will only invest in new capital formation if there is a perceived consumer demand for the product or service. Thus, consumer demand serves as a type of collateral or insurance for a business loan, backed up with sound market projections and a good business plan. As Kelso and Adler point out, however, it is possible to replace the "universal collateralization requirement" with capital credit insurance, using the risk premium assigned to all loans as an insurance premium.

To provide the initial insurance pool and a "failsafe" reinsurance pool, wealthy investors can provide the liquidity, using the funds that can no longer be used for new capital formation, having been replaced with new money created by the banking system. This pool can be treated the same as bank reserves and invested in government bonds, on which (as the government will no longer have access to the discount window for either primary or secondary issues) the rate will necessarily be close to the fair market cost of financial capital.

Given a reasonable reassurance that the loans will be repaid, either out of future income generated by the newly-formed capital or out of the insurance proceeds in the event of default by the borrower, lenders will make loans for capital projects. This will create jobs and increase consumer demand as well as expand the tax base. By putting more people to work, demand for social welfare payments will decrease, lessening the amount the government requires at the same time tax revenues increase. The surplus can be directly applied to debt reduction.

Such a program will require a reorientation in both citizen and government thinking. The State is not there to provide for all our needs, even when we cannot take care of ourselves. Perceived in that way, the State inevitably starts to arrange things so that it must take care of everyone, thereby extending its power and assuming incompatible functions. No, the role of the State is to make it possible for us to take care of ourselves.

A proposal called Capital Homesteading for Every Citizen, from the book with the same title, details a solution to our current situation. It should be taken seriously at all levels of government, but most especially by the new administration, seemingly locked into the self-defeating Keynesian paradigm.

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