Thursday, April 15, 2010

Own the Fed — the Program, Part III: Functional Overload and the Illusion of Control

There is a story, possibly apocryphal, of King Canute the Great (c. 990-1035) becoming so tired of his courtiers' flattery that he decided to teach them a lesson about the real power of kings and, by extension, all temporal power. Having been subjected to such statements that he was the greatest of men, that nothing in the world dared disobey him, that he could command even the elements, Canute is reputed to have arranged a graphic demonstration of what a king or anyone else could really do. As William J. Bennett relates the story,
"So you say I am the greatest man in the world?" he asked them.

"O king," they cried, "there never has been anyone as mighty as you, and there never will be anyone so great, ever again!"

"And you say all things obey me?" Canute asked.

"Absolutely!" they said. "The world bows before you, and gives you honor."

"I see," the king answered. "In that case, bring me my chair, and we will go down to the water."

"At once, your majesty!" They scrambled to carry his royal chair over the sands.

"Bring it closer to the sea," Canute called. "Put it right here, right at the water's edge." He sat down and surveyed the ocean before him. "I notice the tide is coming in. Do you think it will stop if I give the command?"

His officers were puzzled, but they did not dare say no. "Give the order, O great king, and it will obey," one of then assured him.

"Very well. Sea," cried Canute, "I command you to come no further! Waves, stop your rolling! Surf, stop your pounding! Do not dare touch my feet!"

He waited a moment, quietly, and a tiny wave rushed up the sand and lapped at his feet.

"How dare you!" Canute shouted. "Ocean, turn back now! I have ordered you to retreat before me, and now you must obey! Go back!"

And in answer another wave swept forward and curled around the king's feet. The tide came in, just as it always did. The water rose higher and higher. It came up around the king's chair, and wet not only his feet, but also his robe. His officers stood before him, alarmed, and wondering whether he was not mad.

"Well, my friends," Canute said, "it seems I do not have quite so much power as you would have me believe. Perhaps you have learned something today. Perhaps now you will remember there is only one King who is all-powerful, and it is he who rules the sea, and holds the ocean in the hollow of his hand. I suggest you reserve your praises for him." (William J. Bennett, "King Canute at the Seashore," The Book of Virtues. New York: Simon and Schuster, 1996.)
In the previous posting we noted that there are two logical developments that result from the assumption that only existing accumulations of savings can be used to finance capital formation. We covered the first development, the creation and maintenance by an all-powerful State of a public or private elite in order to ensure that there are sufficient savings in the system to finance capital formation. This is a violation of individual justice, that is, a denial of each individual person's inherent (natural) right of access to the means of acquiring and possessing private property in the means of production.

The other logical development from the assumption that only existing accumulations of savings can be used to finance capital formation is a violation of social justice. Briefly, social justice is the virtue directed to the common good. The common good is not a vague concept. The common good is precisely defined as the network of institutions constituting the social order within which human beings as persons develop their humanity to the fullest degree possible. William J. Ferree stresses the fact that the common good is not under the control of an authoritarian ruler or State, and that we are not helpless in the face of seemingly overwhelming social problems. On the contrary,
When it is realized that the Common Good consists of that whole vast complex of institutions, from the simplest "natural medium" of a child's life, to the United Nations itself, then a very comforting fact emerges: Each of these institutions from the lowest and most fleeting "natural medium" to the highest and most enduring organization of nations is the Common Good at that particular level. Therefore everyone, from the smallest and weakest child to the most powerful ruler in the world, can have direct care of the Common Good at his level. (Rev. William J. Ferree, S.M., Ph.D., Introduction to Social Justice (St. Louis, Missouri: Social Justice Review, 1997, 30.)
When the social structures — institutions — of the common good prevent or inhibit people from exercising their natural rights, it is a sign that serious flaws exist in the social order, and a restructuring or reform is in order. Social justice through its "act" is the virtue that "commands" us to organize and carry out that restructuring so that our institutions can function properly to assist each person's full human development. Social justice is thus not directly concerned with the results that follow if our institutions are functioning properly. Instead, social justice concerns correcting institutions so that the institutions can function properly as intended, and thereby provide equality of opportunity, not results. Social justice does not make up for any lack or failure of individual justice, but makes individual justice possible.

Within the context of this discussion, the chief way in which both the State and the Federal Reserve System violate social justice is to assume more and more functions in an effort to guarantee results. This violates the principle of subsidiarity — that all tasks are ordinarily to be performed by those closest to the situation. A "higher" level of an organization should never take over what properly belongs to a "lower" level, and vice versa. It is not a question of the higher or lower level always being "right," but of those individuals and groups most closely concerned with a matter having control over it.

Only when those closest to the matter are unable to bring about necessary reform are the higher levels to act — and then only when those in the lower levels are truly unable to help themselves, individually or in free association with others at that level. Any assistance by the higher levels, however, must be temporary, and directed not at permanently providing what the institutions of the lower level are unable to provide temporarily, but at providing any immediate needs on an emergency (and temporary) basis. The far more important part of the help must be directed towards assisting the lower levels to reform the institutions so that the lower level is once more able to take care of itself without assistance. For a higher level to take over a lower level on a permanent basis is to impose a condition of dependency inconsistent with the demands of human dignity. This condition of dependency is called slavery.

Unfortunately, one of the more popular (if incorrect) understandings of subsidiarity is that the higher levels are required to step in and take over — assume control — when members of the lower level are unable to help themselves individually. This ignores the "social justice power" of organization. Such action violates the principle of subsidiarity by undermining if not destroying the sovereignty of the individuals on whom a condition of dependency is imposed. Doubly unfortunate, it also gives the higher levels all the justification they need to take over and impose slavery — all in the name of social justice. The State and its ancillary agencies become perceived as all-powerful, with no other entity seen as having the ability to effect necessary changes in the common good.

The truth, however, is just the opposite. The demands of individual sovereignty and respect for human dignity require that people be put in positions to control their own lives. In the civil order, this is usually through access to the means of acquiring and possessing private property in the means of production — capital credit. By organizing with others to remove barriers to access to the means of ordinary people becoming owners, humanity acts in accordance with its own nature. As Alexis de Tocqueville pointed out,
The most natural privilege of man, next to the right of acting for himself, is that of combining his exertions with those of his fellow-creatures, and of acting in common with them. I am therefore led to conclude that the right of association is almost as inalienable as the right of personal liberty. No legislator can attack it without impairing the very foundations of society. (Volume I, Chapter XII, "Political Associations in the United States," Democracy in America, 1835.)
If the State or any other institution usurps this "natural privilege of man," it not only violates a basic human right, but takes far more on to itself than it can handle; it approaches, and unavoidably achieves a condition of functional overload. Nevertheless, given this view of the State, the trend inevitably becomes to assign more and more responsibilities to the State and its ancillary agencies — and the power to match — in an effort to make certain that desired objectives are attained.

As the State and the central bank are extremely specialized tools, however, this has led to functional overload of both institutions. The result has been that even the presumed control that the State and the Federal Reserve exercise in their respective spheres is increasingly ineffectual, even counterproductive and self-defeating. This increasing functional overload leads ultimately not only to loss of individual sovereignty and abuse of human dignity, but to chaos.

This chaos is rooted in the fact that neither the State nor its ancillary agencies are quite as powerful or omnipotent as the academics and policymakers would have us believe. The bare fact is that the presumed control the State and the Federal Reserve presumably exercise within their respective spheres is largely a matter of illusion, depending on the acquiescence of the so-called lower levels . . . until they decide they have had enough, or conditions get so bad that the system implodes on its own. In consequence, the sea is coming in, it is even threatening to drown not only them, but the entire State, and they still cannot ease their grip on the illusion of power or consider alternatives to their failed attempts at control.

As Ferree hints, the prevalence of the illusion of control of the lower levels by the higher levels results from a failure to understand essential human nature. This leads to a fatal misunderstanding of specific institutions and their roles, especially the State and money, to say nothing of confusion over the general role of institutions in providing an organized framework within which we develop more fully as humans.

At the most basic level, humans build institutions, including the State and the central bank. Institutions are made to serve, not control, humanity. As artifacts — human constructs — even such seemingly divine institutions as the State and the Federal Reserve can be remade by humanity when flaws are detected. If this is not possible through individual action, social justice dictates that we organize and work as members of groups to restructure our institutions until they conform to universal precepts of justice and meet our wants and needs adequately.

The most serious flaw today in our financial institutions, especially the Federal Reserve System, is a reliance on discredited theories of money and banking. At the heart of the matter (at least with respect to the financial system) is the fixed belief, rooted in the near-religious dogma that only existing accumulations of savings can be used to finance capital formation, that production (and thus jobs) are a derivative of money. Unless the money exists, so the belief goes (that is, unless consumption has been cut and unconsumed income accumulated), there can be no possibility of new capital being financed.

This belief is completely wrong. The exact opposite is the case. Production is not a derivative of money. On the contrary, money is a derivative of production. As Jean-Baptiste Say pointed out to the Reverend Thomas Malthus nearly two centuries ago, we do not purchase what others produce with "money," but with the marketable goods and services we produce. This thing called "money" is merely the mechanism of exchange, a convenience by means of which people trade private property claims back and forth until redeemed. (Jean-Baptiste Say, Letters to Mr. Malthus on Several Subjects of Political Economy and on the Cause of the Stagnation of Commerce. London: Sherwood, Neely & Jones, 1821, 2.)

Anyone with a defined private property stake in an asset with a present value — whether the asset currently exists or is yet in the form of an unrealized if financially feasible capital project — can create money. In essence, all we need to create money is to convince another individual or group to accept that which we offer in exchange. Banks, whether deposit, commercial, or central, were invented to facilitate the transfer of private property rights among individuals and groups. Banks are institutions designed and intended to organize and systematize money creation and exchange. This allows an economy of whatever size to conform to basic principles of justice much more easily by the setting of standards and providing an objective and regular — regulated — way to measure value.

The economic role of the State is to regulate, not to control, create, or produce. The State's job is to set uniform standards of measurement in order to make certain that trade can be carried on with as little confusion and in as orderly a fashion as possible. An inch or an ounce must be the same for every transaction. In the same way, all cents and dollars must have the same value and the same level of confidence, regardless who creates the money.

This is where things appear to have gone wrong. People, especially policymakers and academics, have managed to confuse regulation with control, creation, and production. Nowhere is this more evident than in Keynesian economics. In his Treatise on Money (1930), Keynes declared that the State has the right not just to regulate the form and value of the currency, but to dictate the terms of contracts and even change reality itself by "re-editing the dictionary." (Page 4.)

In other words, in Keynes's view — shared by a significant number of people today — the State not only sets standards and enforces compliance with the law, it dictates in what manner persons can participate in the economic process, and even whether or not something is a "person." By controlling (as opposed to regulating) the creation of money, the State — whether directly or by delegation to a central bank — controls the production of wealth, especially in an economy in which dependence on existing accumulations of savings is assumed as fixed and as immutable as the belief that the sun orbits the earth.

By this means the State, whether or not that was or is its intention, acts as if it believes it controls every aspect of human life, perhaps even the elements and Nature herself. Every citizen — even the fact of personality — depends on the yea or nay of the State. Everyone and everything becomes a "mere creature of the State." (Pierce v. Society of Sisters of the Holy Names of Jesus and Mary, 268 U.S. 510 (1925).) Universal slavery is imposed and maintained in the belief that this arrangement is the only one possible. As Hilaire Belloc pointed out,
To control the production of wealth is to control human life itself. To refuse man the opportunity for the production of wealth is to refuse him the opportunity for life; and, in general, the way in which the production of wealth is by law permitted is the only way in which the citizens can legally exist. (Hilaire Belloc, The Servile State. Indianapolis, Indiana: Liberty Fund, Inc., 1977, 46.)
Aside from the obvious disregard of individual sovereignty and the abuse of human dignity inherent in such a statist approach, however, there is an extremely serious problem with this understanding of human society. Simply put, it isn't real. The State and its agents can re-edit the dictionary all they like. They can even get everyone to go along with the new definitions. Despite that, the State cannot turn black into white or night into day. Not the Congress, the Supreme Court, President Obama, nor even the Federal Reserve itself can, despite all efforts, hold back the sea.

The fact remains: neither the State nor its agencies truly control human life the way people or the authorities within the institutions themselves think. As the great constitutional scholar Albert Venn Dicey pointed out, "public opinion," that is, people's acceptance of certain principles and the perceived conformity of the law with those principles is what makes human positive law effective, not the presumed authority or power of the State. (A. V. Dicey, Lectures on the Relation Between Law and Public Opinion in England in the Nineteenth Century, 1905.) The State can arrange matters so that there is a guard "stationed in every house" (Patrick Henry, Speech to the Virginia Delegates, March 23, 1775.), but if people do not acquiesce on some level, even the most intrusive control will be ineffectual, even destructive of the end sought. Prohibition didn't halt or slow the use of alcohol, but increased it dramatically, as well as providing a means for organized crime to finance an enormous expansion.

Just as the State does not — and cannot — control people's daily lives, the Federal Reserve does not, indeed cannot, control the economy. Once we understand the correct definition of money, we suddenly realize that the Federal Reserve does not and cannot control the money supply or the financial system, either. Most economic activity lies outside the purview of the Federal Reserve System.

A tremendous amount of private sector money creation occurs over which the Federal Reserve exercises no control. In recent years the Federal Reserve has not even included anything other than M1 (coin, currency, and demand deposits) and M2 (M1 plus household holdings of savings deposits, small time deposits, and retail money market mutual funds) in its definition of the stock of money. (http://www.federalreserve.gov/releases/h6/about.htm) The Federal Reserve attempts to track what Milton Friedman called "endogenous (or "internal") money," that is, money created by commercial banks, but does not recognize the vast amount of private sector money that is created without the intermediation of commercial banks. The Federal Reserve does not even have a term for such private sector money.

Unless sold or "discounted" at a financial institution, much of this "private sector money" — "real bills" — never sees the inside of a bank. Most commonly this paper is issued and redeemed in the ordinary course of trade after limited circulation through the channels of commerce. This is "B2B," "Business to Business," and the government has no control over how much is issued, and only limited external control over its quality. Such private sector money can be transformed into general purchasing power by a holder in due course simply by taking the note to a commercial bank. The bank discounts the note, creating banknotes or (more usually) a demand deposit. This, in effect, exchanges the individual credit of the issuer of the note for the more widely recognized and accepted general credit of the bank.

Despite the refusal of the Federal Reserve to recognize the existence of private sector money, private sector money exists. A "quick and dirty" calculation gives a good idea of the quantity of such money and its importance to the economy. The Gross Domestic Product ("GDP") for 2008 for the United States was roughly estimated at $14.3 trillion, according to the International Monetary Fund. (International Monetary Fund, World Economic Outlook Database, April 2009: Nominal GDP list of countries. Data for the year 2008.) To GDP we add imports of $2.523 trillion (U.S. Census Bureau/U.S. Bureau of Economic Analysis, "Exhibit 1: U.S. International Trade in Goods and Services, Jan-Dec 2008," News, U.S. International Trade in Goods and Services, Annual Revision for 2008, 1), for imports are not included in the calculation of GDP. The velocity of money appears to be hovering around 4.1. (Frederic S. Mishkin, The Economics of Money, Banking, and Financial Markets. London: Addison-Wesley, 2004, 520.) Finally, according to the Federal Reserve, the amount of coin, currency, and demand deposits in the United States ("M1") is approximately $1.624 trillion. (http://www.federalreserve.gov/releases/h6/current/h6.htm.)

Using the quantity theory of money equation, M x V = P x Q, we can now make an extremely rough determination of the amount of transactions in the United States in 2008 that resulted from the circulation of M1 and M2. Multiplying M1 plus M2 times the velocity of money (M x V) gives us $6.66 trillion. We subtract $6.66 trillion plus total exports from GDP of $16.823 trillion, leaving $10.163 trillion in transactions that cannot be accounted for — if we assume that M1 plus M2 constitutes the whole of the money supply.

On the basis of this admittedly crude calculation we conclude that the Federal Reserve does not account for — it does not even recognize — more than 60% of the money supply. It thus becomes a serious question not only how the Federal Reserve can claim to control the country in light of the act of social justice, but how it can do so when it doesn't even bother to take into account more than half the transactions in the economy. The unwelcome suggestion starts to surface that the powers-that-be don't really know what is going on. That being the case, how can they expect to know how to correct the situation?

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