Thursday, April 1, 2010

Own the Fed, Part XV: The Great Society

With the advent of the 1960s and the election of John Kennedy to the presidency of the United States, winds of positive change seemed to be blowing away the general malaise of the 1950s, a "New Camelot." Despite the superficial complacency of the previous decade, there were deep undercurrents of stress and discontent not only in the United States, but throughout the world. Worry over communism, civil rights, the ossification of American beliefs and attitudes, particularly in academia — a mental shutdown that came a little earlier than Allan Bloom chronicled (The Closing of the American Mind. New York: Simon and Schuster, 1987) — but especially the growing dependence of a free people on the State — "The System" — which was rapidly reaching the point of functional overload were all symptoms of something off track somewhere. All these things and more signaled something inherently wrong with the social order and humanity's place in society, especially with respect to the economy.

The Hippies were right on at least one thing — there was (and remains) something wrong with The System, man . . . as well as with The System Man. By and large, people, deprived of the control over their own lives and alienated from others through the loss of meaningful private property stakes, had bought into their new dependency status. The "American Dream" subtly changed from sole proprietorship of a farm or small business (an integral part of the community, both politically and economically), to a well-paying wage system job, a house, and a two-car garage.

These are all very nice things to have, but they do nothing to connect anyone directly either to the political or the economic process. Like Charlie Chaplain's character in Modern Times (1936), one becomes — literally — a cog in a machine, replaceable at the will of whoever happens to hold power at the moment. The theme of alienation is pervasive throughout 20th century literature, increasing as the century wore on and more and more people were forced out of direct ownership of the means of production and into the wage and welfare system.

Younger people had not been conditioned to the loss of liberty occasioned by lack of access to the means of acquiring and possessing private property in the means of production. Without the fear engendered by personal experience of the Great Depression and the World War, the generation born since the war was understandably uncomfortable with the conformity the system imposes on anyone who lacks the power to resist. As "power naturally and necessarily follows property" (Daniel Webster, The Massachusetts Convention of 1820), the American middle class was to all intents and purposes powerless, and increasingly dependent on the State to maintain them in their positions. The 1950s rebels without a cause became rebels with a very definite cause in the 1960s: change or destroy an increasingly inhuman system.

While this is only a guess, it's possible that the growth of materialism and consumerism that so turned off the younger generation in the sixties may have been in response to the loss of real power coincident with loss of ownership of the means of production. People may unconsciously have been trying to convince themselves that they weren't quite as powerless as they believed, not if they could acquire some of the increasingly abundant flood of consumer goods and services that made their appearance as technology began rapidly advancing.

Of course, most of them didn't own the technology that was producing the abundance. This caused Say's Law to malfunction. Instead, the propertyless majority relied on an employer or a union backed up with the coercive power of the State to obtain what they considered their fair share. Increasingly, gaining one's "fair share" meant redistributing what the traditional rights of property would have said belonged exclusively to the owner.

As we have already seen as the 20th century advanced, lack of ownership of technology just as technology had the capacity to replace a large measure of human labor in the production process threw a great deal of sand into the economic machine. The sabot that socialism tossed in only made the situation worse. The Keynesian framework requires that effective demand be maintained at adequate levels, regardless of the source of the demand, but usually relying on some form of redistribution through inflation or taxation. Say's Law of Markets, of course, explains that effective demand results from our production of marketable goods and services, which we exchange for the marketable goods and services produced by others through the medium of "money" in a variety of forms.

Locked into the dogma that only existing accumulations of savings can be used to finance capital formation, however, and that only coin, currency, and demand deposits constitute "money," there is a Keynesian tightrope that has to be walked. If you do not redistribute enough effective demand (again, whether through inflation or taxation, depending on what people will stand for), goods and services remain unsold, and business goes into a downturn.

If you redistribute too much, businesses cannot finance new or replacement capital, goods and services are not produced, and business goes into a downturn, and you get inflation besides, as excess effective demand bids up the price of the inadequate supply of marketable goods and services. This is what Moulton called "the economic dilemma" in The Formation of Capital (op. cit., 26-36), concluding that it is an artificial choice forced on people by bad assumptions about the way capital is financed.

What happened during the 1960s was that policymakers were confronted with the Keynesian dilemma that a country cannot produce both "guns and butter," as the case is usually explained in economics texts. As we might expect, the "guns or butter" decision is predicated on the dogmatic (and disproved) belief that there exists only so much in the way of accumulated savings. Consequently a country cannot produce beyond the limits established by the "production possibilities frontier," at least for any sustained period. "Guns or butter" is a way of saying that an economy must choose between using its limited financial resources for defense spending, or to produce consumer goods.

The "Great Society" of the 1960s attempted to eliminate poverty and racial injustice — government-run efforts that (as we might expect) required vast amounts of money, as does every government program ever invented. While elimination of poverty (except through direct ownership of the means of production) and promotion of civil rights (except for the right to direct ownership of the means of production) were primary objectives of the effort, major spending programs also included education, medical care, urban renewal, transportation, consumer protection, the environment, as well as arts and culture.

In many respects, the Great Society might be considered a continuation of the New Deal, carrying it forward into a new generation, at the same time expanding both the scope of the programs as well as the role of the federal government. This led to "neo-conservatism" as a reaction, but the "neo-cons," by and large, differ from traditional liberals only in what they want the State to do, not in their basic assumptions or the degree of State involvement in the economy or the daily lives of people.

Politicians who opposed the war in Vietnam claimed that the spending required to sustain the conflict was taking funds from the Great Society and limiting its effectiveness. On the contrary, whatever the morality or justification of the Vietnam War, cost was not an issue within the Keynesian paradigm — at least not in the sense of draining resources from social programs. The Great Society programs as well as the war were both abundantly funded by creating massive amounts of new money backed by government debt and running up the government deficit.

This, of course, raises the question as to how, if the "guns v. butter" dilemma is inescapable — as the production possibilities curve insists must be the case — how was it possible to have both guns and butter not only during the 1960s, but ever since? Keynesian doctrine claims that even redistribution through inflation or the tax system cannot change the parameters established by the productions possibilities curve. Inflation and taxation can shift demand around, they can even change ineffective demand to effective demand, but they cannot increase aggregate demand — not if we accept the doctrine that only existing accumulations of savings can be used to finance capital formation. How then was it possible in the 1960s to carry on a war in Vietnam and at the same time indulge in what seemed at the time and continues to be an orgy of over-, even grossly conspicuous consumption?

Consumer credit. During the 1960s the use of consumer credit spread rapidly among the middle class. According to the Wall Street Journal of March 12, 2010, per capita household debt is now in excess of $43,000. The buildup appears to have begun in 1950 with the first independent credit card company, Diners Club (now Diners Club International). Consumer credit had always been a serious problem, but it was one usually restricted to the lower economic classes. "Dollar-a-Day Slavery" on the installment plan had reached epidemic proportions by the first decade of the 20th century, as the numerous popular articles and scholarly studies on usury and loan sharking reveal.

In response, the cooperative banking movement gained a great deal of ground. A cooperative bank, of which credit unions are the most common surviving example, is organized to help the poor help themselves through small loans for consumption purposes. As a form of deposit bank, a cooperative bank cannot issue promissory notes (create money), and makes loans only to the extent of its deposits. Micro-lending on the model of Muhammad Yunus's Grameen Bank is a type of cooperative bank. Cooperative banking based on existing accumulations of savings reigned supreme in the first half of the 20th century until replaced by consumer credit cards based on the creation of new money.

Cooperative banking is thus a good use of credit, in the sense that accumulated savings represent unconsumed income. Making a loan out of existing savings for the purposes of consumption is simply putting the savings to proper use. A credit card, however, is a bad use of credit, for it creates money for the purchase of something that does not generate its own repayment. The money so created is not asset backed, but debt backed, relying on the borrower's ability to repay the loan of new money out of other sources of income. To illustrate this point, a brief description of one of the better and more innovative cooperative banking systems might help: the "Morris Plan."

In 1910, at a time when concern over usury and loan sharking was at its height, Norfolk, Virginia attorney Arthur J. Morris opened the Fidelity Savings and Trust Company. The "Morris Plan" was to make small loans to working people for consumption purposes. Fidelity Savings was funded with $20,000 provided by Morris and some associates. It and similar institutions were called "Industrial Banks" not because they financed industrial capital, but because their clientele was drawn primarily from the "industrial classes," i.e., factory workers, the "working poor." The idea spread rapidly, so that by the 1930s there were more than a hundred Morris Plan banks. The number declined after the 1930s when regular commercial banks began offering similar services, and many Morris Plan banks were acquired by or absorbed into established commercial banks.

Morris Plan banks had some unique features that contributed to their loan default rate of less than a tenth of one percent. Loan applicants had to submit references from two other individuals of similar character and earning power. These two people would guarantee the borrower's creditworthiness, and agree to repay the loan if the borrower defaulted. Interest rates were low, contributing to the success of the plan.

With the Studebaker Corporation of South Bend, Indiana, the Morris Plan Company of America (a holding company for Morris Plan banks) was an early innovator in automobile financing. Perhaps most significantly, the Morris Plan Insurance Society was established in 1917 to provide credit life insurance to repay a loan in case a borrower died before it could be repaid, with any amount in excess of the outstanding balance paid to the decedent's estate. This is the earliest use we have found of insurance as a substitute for traditional loan collateral.

As Arthur Morris explained his plan to some financiers who were considering establishing Morris Plan banks throughout the United States,
I told them simply that America's strength was in mass production and the only way to insure mass production was mass consumption. And, like night follows day, we can't have mass consumption without mass credit. And, what's more, mass credit guarantees mass employment. That got them! The only thing I left out, but since have learned was that mass credit would create a standard of living among Americans unequaled anywhere in the world.
Morris's analysis is consistent with that of Moulton, who proved that demand for capital derives from consumer demand. It is not the case, as Keynes asserted, that consumption must be reduced before new capital formation can be financed. As Moulton concluded,
We find no support whatever for the view that capital expansion and the extension of the roundabout process of production may be carried on for years at a time when consumption is declining. The growth of capital and the expansion of consumption are virtually concurrent phenomena. (The Formation of Capital, op. cit., 48.)
In other words, the Morris Plan and other forms of cooperative banking were oriented toward ensuring that existing savings were used not for reinvestment — that was not Morris's concern — but for consumption. This fit in perfectly with Adam Smith's dictum that the purpose of production is consumption, and with Moulton's application of the real bills doctrine to the problem of finding adequate financing for new capital formation when existing accumulations of savings are not sufficient to finance new capital (ibid., 104-106), and cutting consumption would undermine the feasibility of any new capital formed (ibid., 26-36).

Clearly, then, the "old" type of consumer credit (exemplified by the Morris Plan) differs substantially from the "new" type based largely on credit cards. Cooperative banking simply puts savings to their proper use, while credit cards create new money, shifting demand and transferring large amounts of purchasing power through inflation. The problem with both the old and the new style of consumer credit, however, is that it reveals a serious systemic weakness in the economy: the inability of workers to generate sufficient income through labor alone.

Kelso and Adler examined this problem in The Capitalist Manifesto in 1958. They also described a method that could be used that would allow ordinary people without existing accumulations of savings to gain access to capital credit. In a proposal similar to Arthur Morris's use of credit life insurance to collateralize consumer loans, Kelso and Adler advocated capital credit insurance and reinsurance to replace the demand for collateral on productive loans. (The Capitalist Manifesto, op. cit., 243-244.)

Kelso and Adler only touched briefly on the suggestion to use capital credit insurance and reinsurance to replace collateral in The Capitalist Manifesto. In 1961 they published a new book that went into the idea in much greater depth. While a much shorter work — almost an extended journal article — The New Capitalists may, in a sense, be more important than The Capitalist Manifesto, although it shares with the earlier work the use of the ambiguous terms capitalist and capitalism. Despite this presumed flaw, the significance of The New Capitalists is highlighted by its subtitle: "A Proposal to Free Economic Growth from the Slavery of Savings."

Citing Moulton's The Formation of Capital, the proposal detailed in The New Capitalists is to finance the acquisition of corporate equity by ordinary people without savings by using credit extended by commercial banks. According to Kelso and Adler (and substantiated by Moulton) this is how "the rich" have financed the vast amounts of capital they possess. The rich did not accumulate wealth by stealing "surplus value" from workers or consumers.

Instead, acquisition and financing of the new capital is accomplished by cooperating with the commercial banking system to create new money backed by liens on the new capital to be financed with the new money, and secured (collateralized) with accumulated savings, necessarily in the form of existing capital. This employs the concept of "financial feasibility." That is, no new capital is financed (especially with new money created in accordance with the real bills doctrine) until and unless there is a reasonable probability that the new capital will generate sufficient profits to meet the debt service payments and provide an adequate return to the investor. As Moulton explains,
When the managers of modern business corporations contemplate the expansion of capial goods they are forced to consider whether such capital will be profitable. They must begin to pay interest upon borrowed funds immediately and they must hold out the hope of relatively early dividends on stock investments. (The Formation of Capital, op. cit., 29.)
In order to break the stranglehold that doctrinaire reliance on existing accumulations of savings as collateral forces on the economy, Kelso and Adler advocated replacing traditional collateral with a capital credit insurance policy. The risk premium typically charged on all loans (except those made to the extremely risky federal government, which can print money to repay its creditors, thereby shifting the risk to taxpayers and consumers) would be used not by the commercial bank as self insurance, but as the premium on a new type of insurance: capital credit insurance.

For riskier loans, or too many loans of one type held by an insurance company, there should also be reinsurance, or insurance on the insurance. Thus, people without existing accumulations of savings would be able to obtain loans for productive purposes on the same terms as the rich, but with a greater degree of security and scrutiny. Further, the economy would no longer be bound by the artificial constraints imposed by reliance on the discredited production possibilities curve. This would promote full employment of all resources — including human labor. The Kelso proposal would achieve naturally what the Employment Act of 1946 attempted to do by manipulating the money supply and complicating the tax system by transforming what was intended to provide the State with sufficient revenue to carry out its job into a social engineering tool.

Kelso emphasized the full employment of all resources aspect of the plan in The New Capitalists by including a proposal for a "Full Production Act of 19—" in a book he published with Patricia Hetter a few years after The New Capitalists: Two-Factor Theory: The Economics of Reality (New York: Random House, 1967). In his "Explanatory Note" Kelso states,
The Full Production Act of 19—, although useful as a model for economic policy legislation based on two-factor theory . . . has been designed for illustrative purposes to replace the Employment Act of 1946. Since the latter act is generally recognized to be the most important economic policy legislation in the United States, the immediate question arises as to why it should be superseded.

The reason is this: the Employment Act of 1946 is bottomed on one-factor economic theory. It assumes that economic goods and services are produced only by labor, and that capital (the nonhuman factor of production) functions mysteriously to make labor more productive. This is what the "conventional economic wisdom" of our day holds to be true, but in fact, it is not true.

If the function of technology is to shift the burden of production from labor onto capital — that is, to substitute production by the nonhuman factor for human toil; and if the great bulk of our wealth is already produced by capital (rather than by labor), as our eyes tell us is the case, then full employment, even if attainable, is never enough. No household can reach its maximum economic productiveness, no matter how many members of it are employed, nor can it enjoy equality of opportunity for personal leisure and economic security, unless it also owns a viable capital estate. (Two-Factor Theory, op. cit., 167-168.)
The time was drawing closer to when a "prime mover" would recognize (at least in part) the revolutionary wisdom inherent in the Kelso ideas. Unfortunately, other factors were also operating that had — and continue to have — the potential both to inhibit or prevent effective implementation of the ideas, as well as provide another trigger that would bring the economy down in a crash far worse than that of 1929.



nail-in-the-wall said...

Well Done!
You would make Kelso -Proud-

nail-in-the-wall said...

Well Done! Michael

Louis O. Kelso would be -PROUD-

Guy Stevenson