In the previous posting in this series, we discovered that it is not sufficient to call something a free market, and yet ignore everything that makes a market free. The institution that alone has the potential to make or keep a market free is widespread direct ownership of the means of production. From this it follows logically that, even if everyone has a legal right to be an owner, that right is meaningless unless 1) someone actually is an owner, and 2) that ownership is real ownership. This posting covers what we mean by "ownership," that is, the rights of private property.
Our task, therefore, is to define what we mean by "property." We already know that this thing we call property is somehow important, but that realization doesn't do us much good until and unless we know of what this important thing called property consists.
First off, most people assume that when you say "property," you are referring to what someone owns. That is close — but not close enough. Rather, property is the natural right every human being has to be an owner, and the socially determined bundle of rights that define how an owner may use that which he or she possesses. That is, property is the right to and the rights over a thing that is owned; it is not the thing itself.
Unfortunately, for many people in the world today, this is a meaningless distinction. With the exception of their labor, which is declining in value relative to technology as technology becomes increasingly productive, most people do not have private property in anything that could be considered productive. Those people that do possess a few equity shares representing a nominal minority ownership interest in a business enterprise frequently do not enjoy the full bundle of rights that necessarily accompany ownership.
While the opportunity to become an owner of the means of production is generally considered a hallmark of "free market capitalism" in the United States, that opportunity (as we have already seen) is as meaningless as the oxymoronic equation of the free market with capitalism. Adding insult to injury, unless a shareholder has a controlling interest in a company, the courts have decided that the only effective right that the shareholder can exercise is to sell the asset. The most important rights of private property — the rights to enjoy the income generated by and to control the disposition of what is owned — are completely subject to the whim of whoever has a controlling interest.
Ironically, the stripping of rights from minority owners — a direct, full frontal assault on the institution of private property — is due in large measure to the actions by one of the "high priests of capitalism": Henry Ford. Frankly, capitalism is only marginally palatable because, however distorted, it is based on the natural right to private property and the correlative rights of private property. By effectively taking away the principal rights of private property — the right to enjoy the income generated by and otherwise exercise control over what is owned — Henry Ford sabotaged the very system he is credited with helping to establish and maintain. How this came about is a story that is almost epic in scope.
In the first quarter of the 20th century, Henry Ford decided to finance a plant expansion using retained earnings instead of selling new equity or borrowing the money. The Dodge brothers, minority owners, protested. They wanted the dividends to which they were entitled under the traditional rights of private property. Ford refused to pay dividends. The Dodge brothers sued.
In Dodge v. Ford Motor Company (204 Mich. 459, 170 N.W. 668. (Mich. 1919)), among other issues, the court redefined the traditional right to receive the "fruits of ownership" (i.e., income from what is owned — dividends) for minority shareholders as limited to the power to sell their shares if they weren't happy with the dividend policy of the majority owner(s).
The court ruled, in effect, that minority shareholders are able to enjoy their full "fruits of ownership," including the right to receive any and all income generated by what is owned, only if the majority owner so agrees. That is, the majority owner(s) in the person of the Chairman of the corporate Board of Directors alone has the right to set dividend policy for a company, and does not need the consent of a minority owner or owner(s) to withhold that which belongs by right to the minority owner(s).
Henry Ford built his defense on the "business judgment rule." That is, if the individual elected by the shareholders (who happened to be Henry Ford, as he retained the majority block of shares) decided it was in the best interests of the company — and therefore the shareholders — to stop payment of dividends, the minority shareholders had no recourse other than to retain their shares and take whatever the majority owner(s) chose to dish out. The alternative was to exercise their "take-it-or-leave-it" right to sell their shares and wash their hands of the whole business — in other words, exercise their property rights solely to become non-owners.
What is also frequently ignored in analyses of the case is the fact that Henry Ford had dismissed another right of private property, that of control. He had previously blocked every effort of the minority shareholders to have input into decisions and exercise some degree of control over the business, such as design improvements and marketing strategy. This was particularly egregious with respect to the Dodge brothers, who owned the next largest block of shares (10%) after Henry Ford, and who were increasingly unhappy with Ford's dictatorial actions.
Consequently, prior to their lawsuit over Ford's restriction of dividend payments, the Dodge brothers began setting up their own automobile manufacturing company in secret, using their Ford dividends to finance the effort. Ford got wind of this and began withholding dividends. Ford was also suspected of wanting to reduce the price of Ford automobiles as a way of justifying the proposed reduction in dividend payouts and reducing the company value per share.
After the Michigan Supreme Court ruled in his favor, Ford threatened to set up another rival automobile manufacturing company, probably to be wholly-owned by Ford personally, apparently as a way to compel the Dodge brothers to sell their shares back to the Ford Motor Company at the reduced value per share that Ford had manipulated. In this he was successful — and thereby undermined another right of private property, that of disposal, by taking away the Dodge brothers' free choice in the matter of whether or not to sell their shares.
It was, however, a Pyrrhic victory. The Dodge brothers used the proceeds of the forced sale to complete setting up their own automobile manufacturing company. They soon designed and marketed an automobile that many car enthusiasts still consider one of the best popular vehicles ever built, the 1926 Dodge. This made the venerable Model T Ford, the basic design of which Henry Ford had resisted changing for almost twenty years (1908-1927), obsolete. Henry Ford was forced to invest vast sums in developing a competitor to the Dodge product, and spent millions more retooling his factories to produce the Model A in 1928. His refusal to share power and pay dividends to minority shareholders cost Henry Ford a huge fortune, and ensured that his company lost its position as the world's leading automobile manufacturer.
Aside from the personal cost to Henry Ford, the social cost of Dodge v. Ford Motor Company was enormous. It embodied the attenuation of the property rights of minority shareholders into law, economic theory, and fiscal and monetary policy — and thus into the United States Internal Revenue Code. The consequences of this action were profound and far-reaching.
An owner has the right to the profits generated by what he or she owns. Denying this right, as Henry Ford did to the Dodge brothers, abolishes private property to that degree. Common myths about how capital formation is financed provide the justification for this undermining of a natural right. There are two essential reasons for this.
One, capital isn't usually financed out of existing accumulations of savings — directly. The chief use of savings (which necessarily equals investment, as Keynes agreed, indeed, insisted on) is as collateral for debt financing. Henry Ford undermined the natural right to private property in two ways by accumulating cash to finance plant expansion: 1) he denied the Dodge brothers their fruits of ownership by withholding dividends, and 2) he violated principles of sound finance embodied in the real bills doctrine, thereby monopolizing access to the means of acquiring and possessing private property.
Two, Henry Ford's chosen method of concentrating ownership — and thus power — in his own hands guaranteed that he would be accountable to no one for any of his actions. By concentrating ownership, Ford effectively negated others' right to be an owner, and actually went so far as to work to strip others not only of the rights of ownership, but of ownership itself.
While unacknowledged, Dodge v. Ford Motor Company helped set the stage for the Crash of 1929 and the current financial crisis. It did this by shifting the incentive for share ownership from anticipation of a future stream of dividends, to speculation in the value per share itself. "Investment" became redefined in the popular mind (and in that of many financial professionals) as buying and selling in anticipation of a rise or fall in the value per share, not in putting resources to work in a productive endeavor to generate income. The result was a near-total divorce of "investment" and share ownership from the revenue stream generated by profits of production.
Fortunately, just as the traditional rights of private property were eroded by a bad court decision, they can be restored by the stroke of a pen. Since people's behavior naturally tends to follow the most advantageous course, people would soon reorient their investment strategy to conform to the restoration of the rights of property. The difficult part will be convincing lawmakers and academics that using retained earnings, either directly to finance capital formation or (more usually) as collateral to secure new money creation is contrary to sound finance and undermines the political stability of the State.
The fact is, while corporate finance is demonstrably not carried on in the manner described in academics' textbooks or by the nation's policymakers, such centers of influence and power continue to insist, contrary to absolutely certain historical and mathematical proof, that new capital formation is always, without exception, financed out of existing accumulations of savings.
Giving the lengthy proofs contradicting the dogmatic belief in the necessity of existing accumulations of savings to finance capital formation is not the intent of this blog series, and it would be a diversion in any event. The theoretical basis of financing new capital formation, the real bills doctrine, can be found in the work of Adam Smith (The Wealth of Nations, 1776), Henry Thornton (An Enquiry into the Nature and Effects of the Paper Credit of Great Britain, 1802), Jean-Baptiste Say (Treatise on Political Economy, 1821; Letters to Mr. Malthus, 1821), and John Fullarton (Regulation of Currencies of the Bank of England, 1844). Practical application and empirical proof can be found primarily in the work of Dr. Harold G. Moulton (chiefly The Formation of Capital, 1935), with corroboration and verification found in the work of Louis Kelso and Mortimer Adler (The New Capitalists, 1961). In this context, the subtitle of Kelso and Adler's book is significant: "A Proposal to Free Economic Growth from the Slavery of Savings."
The bottom line, of course, is that the mechanics of restoring the rights of private property are almost ridiculously easy, not to say straightforward and simple. The hard part is convincing academics and policymakers of the desirability of the only thing that has any hope of restoring a sound economy, and thus of maintaining a stable political order.
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