News from the Network, Vol. 3, No. 21

The stock market dipped below 10K this week. We were terrified. Not. We realize, though, that a number of people are justifiably scared to death. Retirees are seeing both their defined benefit pension plans and their personal investments evaporate. Workers are seeing the economy crumble and their futures disappear. At choir practice last night, it was something of a grim contest to see who knew the most people who had been laid off from their jobs.

Nevertheless, in spite of the growing gargantuan Keynesian deficits, the "fine turning" of the economy (so fine that the market keeps going up and down in greater and greater swings), and the fine tuning of the fine tuning . . . whether or not you can stomach the dissonance of the economic orchestra . . . the economic experts and policymakers keep assuring us that the recession is over, and the recovery is right on target.

We agree: the recession is over. We are now in a depression. That's because only in Keynesian Deficitland can going deeper and deeper into debt, inflating then devaluing the currency, diverting critical financial resources to prop up failed companies, funding gambling and speculation on the secondary markets, and starving the productive sector for financing — the primary market — be termed "recovery." Their song is ended, but the malady lingers on.

As Mark Spitznagel commented on the current monetary policy of the Federal Reserve in the Wall Street Journal this morning, "All in all, it seemed like an impressively engineered recovery. In reality, it was an ephemeral illusion caused by distorting investors' assessment of risk. Despite what zero interest rates were signaling, savers flush with cash weren't flooding the capital markets and credit wasn't expanding." (Mark Spitznagel, "The Fed and the May 6 'Flash Crash'," The Wall Street Journal, 05/28/10, A17.)

Well . . . credit wasn't expanding for productive purposes. Credit expanded at an incredible rate — a minimum of $1.2 trillion — to finance the purchase of toxic, "mortgage-backed securities" by the Federal Reserve. This was an egregious misuse of the money creation powers of the central bank. The Federal Reserve was established in 1913 to get the control over money and credit out of the hands of gamblers and speculators, keep the money power out of the hands of the politicians, and provide an "elastic currency" that expands and contracts according to the needs of the private sector, not the State. The currency, linked to gold to provide stability and a standard measure of value, was supposed to be backed not by massive government debt and toxic assets, but by private property rights in the present value of properly vetted and qualified industrial, commercial, and agricultural assets.

The gold isn't strictly necessary, but backing the currency with hard assets in the form of financially feasible (i.e., that pays for itself out of future profits) capital is essential. If you're keeping up with the new "Out of the Depths" blog series that we started this week covering various French financial experiments, you'll soon see what happens when the State cranks up the printing presses under the illusion that spending increasing amounts of money backed only by the State's promise to pay instead of hard assets in the form of productive capital. The only possible outcome is, and will always be, disaster.

So why aren't we sharing in the general rise in the fear level? Because we have a solution: the Just Third Way. It only requires that we get the word out into quarters where it will do the most good. That means you opening doors and presenting people in power with an alternative to the insanity of Keynesian deficits and "solutions" that promise to get us out of a sinkhole by digging us in deeper. To help you open doors, we have the CESJ website, and a growing amount of material presenting parts of the Just Third Way. For example,

• Hold your fingers and cross your breath. We expect to have our edition of Dr. Harold G. Moulton's The Formation of Capital out in the next couple of weeks. We'll let you know immediately how much, where, bulk/wholesale discounts, etc. Moulton was the first president of the Brookings Institution, Washington, DC's first "think tank," serving from 1916 to 1952 in that capacity. In 1934 and 1935 Brookings published a four-volume series on recovery from the Great Depression. Of the four-volume set (America's Capacity to Produce, 1934, America's Capacity to Consume, 1934, The Formation of Capital, 1935, and Income and Economic Progress, 1935), The Formation of Capital is the most relevant in our day and age and to the present economic situation. For one thing, Moulton's book shows how new capital can be financed without relying on the existing accumulations of the rich. Let the rich spend their money and have some fun. They can benefit the rest of humanity by giving Adam Smith's invisible hand a good, firm shake by increasing effective demand in the economy. For another, . . . actually, the most important thing at this point, new money can be created without running up government deficits à la Lord Keynes, the world's leading defunct economist to whom most of the world is enslaved. Income and Economic Progress, the "sequel" to The Formation of Capital, is insightful and interesting, but something of a "period piece." A more advanced and comprehensive proposal to "free economic growth from the slavery of savings" can be found in the two books co-authored by Louis O. Kelso and Mortimer J. Adler, The Capitalist Manifesto (1958), and The New Capitalists (1961). Not surprisingly, The New Capitalists cites Moulton's work at great length, and has the subtitle, "A Proposal to Free Economic Growth from the Slavery of Savings." Sound familiar? A specific program applying these principles can be found in Capital Homesteading for Every Citizen (2004).

• As usual, a number of very good meetings took place this week. Unfortunately, the nature of these meetings is such that until they start to bear fruit, there really isn't too much to say other than "Some meetings took place . . ."

• In the "Small is Beautiful" department, it is quite common for people who are baffled by today's economic and financial meltdown (which class includes pretty much anyone who lacks a working knowledge of binary economics and Capital Homesteading) to recommend a program of breaking things up, bringing them down to something vaguely termed "human scale" — which begs the question if you don't first define what you mean by "human." What they usually mean, of course, is that anything that is too big for a single individual to handle alone is beyond "human scale." This, however, contradicts Aristotle and his observation that "man is by nature a political animal" (The Politics, I.ii.) That means that people naturally join together to undertake tasks that are too big for one person. That is the whole point of "social justice." To promote the idea that "small is beautiful," supporters often insist that consumers should be prepared to make a sacrifice and pay more for goods and services provided by individuals and small companies, eschewing the less expensive products of big companies. We disagree, but if somebody else wants to pay more to get less, that is his or her choice. You can imagine our surprise, then, when a "small is beautiful" supporter chastised us rather severely recently for not being able to offer our publications at the standard industry discount of 55%. We use print on demand technology, which triples or quadruples the individual unit cost. That's fine — it also means that we don't tie up c. $50,000 or more in working capital in inventory that might not sell (and where would we store it?), and what would ordinarily be a fixed cost is now a variable cost. Print on demand technology is significantly more cost effective than regular printing for a small operation — with the downside that you can't beat the wholesale or bulk prices demanded or offered by the Big Boys. That's fine, too. They have their niche, which is volume sales of popular books. Smaller operations like think tanks with extremely specialized publications also have their niche . . . and must make up for the lack of volume with higher prices in order to cover costs.

• Nevertheless, we have a number of publishing projects in the pipeline (unfortunately not including a handbook on how to cut down on alliteration, thereby putting period to a possibly profitable publishing program). Among these are Supporting Life, an economic agenda for the Pro-Life and genuinely Pro-Choice movements, The Political Animal, a brief look at the place of the human person in society from a Just Third Way perspective, The Restoration of Property, an examination of the role of private property in the means of production in securing and protecting personal sovereignty, The Single Rate Tax, an outline of proposed tax reforms that would, if adopted, allow a "typical" family of four to avoid ALL taxes on income (including Social Security and Medicare) until aggregate income exceeded $100,000, and the current series on French Financial Experiments that focuses on disproving the weird Keynesian belief that you can get out of financial difficulties by making them worse. (Actually, the point of the series is that the only real way to get out of debt is to start producing — and producing in a way in which everyone can participate as owners of both labor and capital. Keynes may have believed otherwise, but you can't keep dividing up a shrinking pie by inflation and government deficits forever.)

• As of this morning, we have had visitors from 43 different countries and 43 states and provinces in the United States and Canada to this blog over the past two months. Most visitors are from the United States, the UK, Canada, Brazil, and India. People in Belgium, Egypt, Romania, Maldives, and the United States spent the most average time on the blog. The most popular posting is the weekly "News from the Network" with three of the top five spots, followed by "Thomas Hobbes on Private Property," and the "Prologue" to the new "Out of the Depths" series on French financial experiments (it has a happy ending and an object lesson for the United States on how to get out from under a crushing burden of debt).

Those are the happenings for this week, at least that we know about. If you have an accomplishment that you think should be listed, send us a note about it at mgreaney [at] cesj [dot] org, and we'll see that it gets into the next "issue." If you have a short (250-400 word) comment on a specific posting, please enter your comments in the blog — do not send them to us to post for you. All comments are moderated anyway, so we'll see it before it goes up.

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Out of the Depths, Part II: Monsieur Law and His System

Despite what we might read in bad romance novels and, sometimes, worse history about the quantities of gold Guineas and silver Shillings flung about with abandon from carriages and across gaming tables, the coinage of Great Britain was grossly inadequate even for England at the end of the 17th and the beginning of the 18th centuries. That being the case, the other members of the United Kingdom were pretty much left to fend for themselves. It was fortunate that Scotland had a well-established and soundly organized commercial banking system in place that could respond to part of the demand for money and credit in a limited fashion. Economic activity would otherwise have become as difficult as it was in Ireland or the American colonies.

The Scottish System

The Scottish banking system was both ingenious and sound, deserving a much more extensive treatment than we can give it here. To understand what John Law did in France, however, we have to understand the background against which his knowledge of money and credit developed.

The Bank of England was established in 1694, and the Bank of Scotland the year after. These banks, however, were first intended only to provide commercial interests with banking facilities and offer discount accommodation for bills of exchange — changing private obligations of individual mercantile firms into generally accepted obligations of the commercial bank. This was a tremendous boost to economic growth — up to a point.

The problem was, while commercial bank discounting supplied the mercantile houses with liquidity, it did next to nothing to supply common circulating media for the general public. This was a serious deficiency that was to plague England until the "New Coinage" of 1816 finally put the currency of the United Kingdom on a sound basis. (James Mackay, A History of Modern English Coinage: Henry VII to Elizabeth II. New York: Longman, Inc., 1984, 129-133.)

The case was different in Scotland. The crown chartered two banks in Scotland. These were the Bank of Scotland in 1695, and the Royal Bank of Scotland in 1727. Unlike the Bank of England, however, these were not granted a monopoly or any other exclusive privilege. Consequently, a large number of private banks were also established. This forced the chartered royal banks to compete in the free market on the same terms as any other commercial bank.

There was another unique aspect of the Scots banking system. In an effort to garner as much banking business as possible, the Scots banks invented a new kind of loan, what is today called a "line of credit." Today this type of loan is quite common, but in the late 17th and early 18th century it was revolutionary. As Richard Hildreth described the innovation,

The Scotch Bankers, instead of confining themselves to the discount of mercantile paper, open what they call cash accounts; that is, upon the credit of a bond for repayment, signed by three responsible persons, they agree to advance money, for a certain time and to a certain amount, to the individual with whom the account is opened; but he is not obliged to draw out the money except at such times and to such amounts as he may think proper; interest begins only from the payment of his drafts; and he is at liberty to pay money into the bank, according to his own convenience, which payments cancel so much of his debt to the bank, and stop the interest upon it. (Richard Hildreth, The History of Banks. Boston: Hilliard, Gray & Company, 1837, 15-16.)

The Scottish system represented the highest development of "free banking," something widely misunderstood today. The concept and principles of free banking have been seriously eroded with the rejection of the real bills doctrine, and the reinterpretation of free banking as a form of deposit banking instead of issue banking (vide Vera C. Smith, The Rationale of Central Banking and the Free Banking Alternative. Indianapolis, Indiana: Liberty Fund, Inc., 1990). As Conant observed,

The Scotch system of banks of issue comes nearer to the ideal of successful free banking than that of any other country. Absolute freedom in note issues reigned for over one hundred years in Scotland, and during eighty years of that period general distrust of the banking system never occurred, small notes became the favorite medium of exchange among the people, and the deposits in the banks absorbed almost the entire savings of rich and poor and brought within the circle of active producing capital the entire accumulations of the country. Such defects as were disclosed in the early years of Scotch banking were corrected with experience, and the few departures which have taken place from sound principles have been such as to suggest no change in the established practice of the majority of Scotch banks, but, at the most, some official regulation which should hold all to the rules voluntarily adopted by the oldest banks and the soundest bankers. (Conant, op. cit., 142.)

John Law's Background

Coming from this financial environment in which competition and innovation were encouraged, it comes as no surprise that John Law was able to formulate his own revolutionary ideas about money and credit. He developed principles that, however poorly understood and badly implemented in practice, are fundamentally sound. At the start of his career, however, John Law probably had no thought of attempting a general reform of the world banking and currency system. In 1688, on the death of his father, he took himself to London to sport with the ladies (he was known as "Beau Law" amongst his set in Scotland) and "see the world."

John Law, however, was a Scotsman, and one who considered himself a gentleman. Reading Boswell's Life of Johnson, one is struck by the casual contempt or outright hostility that the English of that period had for the Scots, at least those Scots attempting to hold themselves out as equals of the English or English gentlemen. Possibly inspired in part by some need to demonstrate that he was at least as much of a gentleman as any Englishman, John Law managed to get himself involved in the gentlemanly pastime of dueling.

Law "killed his man" in a "Love Duel" in Bloomsbury Square, was arrested, and convicted. He fled the country to avoid sentence being carried out. He ended up in Holland where, presumably, the Dutch expertise in banks, loans and other financial matters gave him inspiration for his theories. A while back the Dutch had, after all, established one of the earliest banks that presaged the development of the concept of central banking, the Bank of Amsterdam (modeled on the Bank of Venice), and thus could be considered in the forefront of financial innovation.

The Bank of Amsterdam was not, of course, a bank of issue. It was, instead, a bank of deposit, but with an innovation. It took deposits of coin, and issued receipts against the deposited specie. Naturally, these receipts, called "bank money," soon circulated as a type of currency. This bank money was declared sole legal tender for the payment of all bills of exchange in excess of 600 Guilders. (Hildreth, op. cit., 9.) As Hildreth described the operation of the Bank of Amsterdam,

It received coin and bullion upon deposit on the following terms. When the coin or bullion was deposited, a certain sum of bank money was transferred to the account of the depositor, equivalent to the current value of the coin or the mint price of the bullion, with a small deduction varying according to circumstances. At the same time a receipt was issued to the depositor, entitling him or any bearer, to withdraw the coin or bullion from the bank, at any time within six months from the date of the receipt, first transferring to the bank, the same sum of bank money which had been granted to the depositor, and paying a commission for the keeping, . . . The profits of the bank were made by these commissions, and by the premium it obtained on the sale of coin, bullion, and bank money. It made no loans; and therein differed essentially from our modern banks. (Hildreth, op. cit., 9-10.)

One source claimed that John Law visited the American colonies soon after his departure from England, and there observed the land banks in operation under the various colonial governments. He is said to have witnessed their success, but did not stay around long enough to see the disastrous end result. (Angell, op. cit., 244.) Considering the difficulty of travel during the period, the relatively short time involved, the fact that other sources make no mention of Law's presumed American sojourn, as well as recognizing that a convicted murderer would have been extradited, the story is probably apocryphal, particularly as the source only related the story of John Law in order to discredit all paper money.

It is believed that after spending some time on the continent, John Law returned to Edinburgh around 1700. It was there that he published a pamphlet entitled, Proposals and Reasons for Constituting a Council of Trade. It is not, however, absolutely certain that he personally supervised publication. A few years later Law published his Money and Trade Considered. As we will see, this short work attracted a great deal of attention in the Scottish Parliament. Law's proposal for Scotland was to ameliorate the perennial shortage of current money by extending the land bank system to the economy as a whole.

Apparently Law didn't realize at the time that basing the currency on a limited asset — land — is just as constraining as using specie exclusively. He was making what Henry Dunning MacLeod identified as a fundamental error: that money either is or directly represents an existing commodity. MacLeod very carefully explains the subtlety of Law's error, which is the same as those whom Joseph Schumpeter termed "the bullionist school," and which are best represented today by the Austrian School of economics.

As MacLeod explained, Law's proposal, as it stood at this time, "was a violation of that fundamental principle we have obtained, — 'Where there is no debt there can be no currency'." (Henry Dunning MacLeod, The Theory and Practice of Banking. London: Longmans, Green, and Co., 1906, 253.) In more modern terms, money is not the commodity or anything else that backs the money. Money is a derivative of wealth, not wealth itself. What backs money is the present value of existing and future marketable goods and services, not the marketable goods and services. That is, money is backed by property in (ownership of) the present value of existing and future marketable goods and services, not the actual marketable goods and services.

This distinction may be too subtle for many people. It relies on grasping the difference in the accounting equation between net assets and owners' equity. This is where John Maynard Keynes got hung up. It is also, possibly, why he insisted that new capital formation could not be financed except by cutting consumption, accumulating savings, then investing. Keynes appears unconsciously to have leaped from "savings equals investment" (i.e., assets equal liabilities plus owners' equity), to "savings are investment"; that ownership or property in a thing is the same as the thing itself. (Vide Harold G. Moulton, Capital Expansion, Employment, and Economic Stability. Washington, DC: The Brookings Institution, 1940, 26.)

Returning to the error in Law's proposal, basing economic development and commercial activity exclusively on any commodity that is fixed in quantity (that is, accumulated savings) has serious consequences when there is an inadequate amount available — or too much. This was the case throughout Europe, but especially in Scotland and England. Wales and Ireland were generally ignored when it came to economic development at this period. As Conant remarked,

Ireland has had almost as varied an experience in banking as in the political fortunes of her people and her banking history has been affected more or less unfavorably by the agitated condition of the country. The policy of England towards Ireland was distinctly selfish during the seventeenth and eighteenth centuries. (Conant, op. cit., 171.)

Scotland's Monetary and Financial System

For all their financial and historical significance, Scottish paper money from the late 17th and early 18th centuries are, frankly, extremely ordinary in appearance, and are inadequately cataloged. Due to the very success of the system, notes are extraordinarily hard to come by, and specimens for study are rare. Many issues before 1780 are offered for sale so infrequently that they do not even have prices listed in hobby catalogues. In appearance, they all have a basic "certificate" look, making for an extremely dull impression all out of proportion to their actual importance.

Scotland's metallic currency is more interesting, at least in appearance. In the late 17th, early 18th centuries, Scottish current coin consisted of a perfunctory mintage of gold Pistoles and Half-pistoles (Five Dollars and 2-1/2 Dollars, respectively), and a somewhat larger coinage of shilling-denominated silver pieces: Five, 10, 20, 40 and 60 Shillings. There was a modest coinage of copper Bawbees (Six Pence) and Bodles (Two Pence, also called "Turners"), but, as the huge number of privately issued tokens indicates, the official coinage was inadequate to the task of providing sufficient small change. Because of close commercial ties with Northern Ireland, many Scots tokens circulated there, and many tokens produced in Northern Ireland were in the Two Pence denomination, which passed as Turners. (Peter Seaby, Seaby's Standard Catalogue, Part 3: Coins and Tokens of Ireland. London, B. A. Seaby, Ltd., 1970, 140.)

At this time, the Scots 60 Shillings was the equivalent of the French Ecu of Six Livres, which was valued, according to James Simon's 1749 Essay on Irish Coins (which has several charts giving the value of foreign coin in Ireland in both English and Irish currency) at 54 Pence, or 4s 6d. This is a little less than the Five Shillings given as the equivalent in Seaby's Catalogue, Coins of Scotland, Ireland and the Islands. The Scots 40 Shillings was the equivalent of the French Four Livres, while the 10 and 20 Shillings matched the One and Two Livres, respectively. The Scots 60 Shillings was also the equivalent of the 60 Schilling of the German-Danish Duchy of Schleswig-Holstein and other middle European states, which was itself the equivalent of the old Reichsspeziesthaler ("Imperial Silver Dollar"). This had the advantage of fitting the Scottish system conveniently into the prevalent systems on the continent.

The paucity of gold and especially silver coinage, as well as the basic inadequacies of backing the paper currency exclusively with land put a severe crimp in economic development that was not assuaged with the establishment of the Bank of England. Although intended as a means of supplying commerce and industry with adequate supplies of money and credit, the Bank of England, in common with most central banks the world over, soon became a means of financing government deficits, letting the commercial world fend for itself or at the behest or sufferance of the State.

Deflation and Inflation

Due to the scarcity of money, economic development was still hampered in England even after the founding of the Bank of England, an institution designed specifically to solve the problem. This precluded any immediate extension of the system to Scotland, even after the 1707 Act of Union. The bank was hijacked to political purposes by becoming the chief financial agent of the government and issuing enormous loans to the State. It was never a case of financial interests or "international bankers" sabotaging the world's money supply and controlling the world by taking over the government's financial system, but of government taking over control of the financial system for its own purposes. (Vide Henry C. Adams, Public Debts: An Essay in the Science of Finance. New York: D. Appleton and Company, 1898, 22-23.)

Ironically, the severe deflation of the day followed the chronic inflation that resulted from the influx of gold and silver from the mines in the New World. John Law was prescient enough to see that artificially limiting money and credit was a recipe for economic stagnation and decline. He published his theories in Money And Trade Considered With A Proposal For Supplying The Nation With Money (Edinburgh: Andrew Anderson, 1705). This treatise represented a limited version of the concept he later applied in France, albeit with the flaw we noted previously associated with backing money with a marketable good or service, especially one in limited quantity, instead of the present value of existing and future marketable goods and services.

Law's argument took into account the well-known conservatism of financial interests, and made the case for basing the currency exclusively on land. It was, admittedly, far easier for people to understand land as a productive asset than manufactories and trade. Whatever its merit, however, the Scottish parliament did not adopt Law's proposal. As Mackay related,

In a short time afterwards he published a project for establishing what he called a Land-Bank (The wits of the day called it a sand-bank, which would wreck the vessel of the state), the notes issued by which were never to exceed the value of the entire lands of the state, upon ordinary interest, or were to be equal in value to the land, with the right to enter into possession at a certain time. The project excited a good deal of discussion in the Scottish Parliament, and a motion for the establishment of such a bank was brought forward by a neutral party, called the Squadrone, whom Law had interested in his favour. The Parliament ultimately passed a resolution to the effect, that, to establish any kind of paper credit, so as to force it to pass [i.e., have legal tender status], was an improper expedient for the nation. (Charles Mackay, op. cit., 4.)

While rejected by the parliament and frequently excoriated, if not ridiculed by later economists and historians, the basic plan could not have been more sound. In light of the demonstrated inadequacy of metallic currency, Law proposed to form a bank of issue, with the notes backed by the value of the State's landed property. This would have extended the existing system of land banks, which monetized private land holdings, to the nation as a whole.

Law's proposal is almost identical to the "Rentenmark" plan implemented by Dr. Hjalmar Schacht that saved Germany in the 1920s. Schacht's plan brought a halt to the hyperinflation. Similar to the way the French Regent was to seize control of Law's "system," Schacht's plan was itself endangered when certain interests in Germany tried to manipulate the system through speculation before Schacht, unlike Law, was able to reassert control. (Vide Hjalmar Horace Greeley Schacht, Confessions of "The Old Wizard." Boston: Moughton Mifflin Company, 1956, 162-164, 198; John Weitz, Hitler's Banker: Hjalmar Horace Greeley Schacht. New York: Little, Brown and Company, 1997, 66-68, 70-71, 84-85.)

Failing both in his land bank project and to obtain a pardon for the murder, Law either remained on the continent or quickly removed there. For about fifteen years he roamed about Europe, apparently supporting himself by gambling. His considerable dexterity in mathematics played no small part in his success as a gamester. He was expelled from various world capitals as a bad influence on youth. While there is no record that he was ever anything but straight in his play, his gambling success apparently gave the worst sort of example to idle highborn lads with money in their pockets.

In France in 1708, John Law was about to be thrown out of Paris when he made friends with the Duc d'Orléans, a powerful and influential nobleman. This prevented Law's immediate deportation, but, when his banking scheme was proposed to Louis XIV, that monarch asked if the projector was Catholic. Receiving an answer in the negative, the Sun King refused to have anything to do with a "Huguenot," a somewhat reactionary if ultimately wise decision, given the enormous influence of the Duc d'Orléans and the way he managed in the end to seize control of the project. Almost immediately d'Argenson, then chief of police, had Law expelled from France as a suspicious character, possibly more to curry favor with the king than because he truly believed Law to be shady.

A few years later Law found himself in Italy and proposed the scheme to the Duke of Savoy. He was again refused, but the Duke encouraged him to try France again. That country should be wide-open for such a plan, with the recent death of the old king, the nation groaning under a large burden of debt, and the new, seven-year-old king under the charge of a regent — the Duc d'Orléans.

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Out of the Depths, Part I: An Introduction to Money and Banking

No one in his day understood the principles of sound paper currency, credit, and banking better than he — and no one managed to cause more trouble through the misapplication of those same principles. Truth be told, however, much of the opprobrium or praise heaped upon John Law depends on our understanding of money itself. (The basic outline of John Law's career is taken from Charles Mackay, Extraordinary Popular Delusions and the Madness of Crowds. New York: Farrar, Straus and Giroux, 1932, a fairly objective account of the events surrounding the "Mississippi Bubble.")

What is "Money"?

Despite all the mystery piled onto the concept of money, it is a very simple thing to understand. "Money" is anything that can be used in settlement of a debt. ("Money," Black's Law Dictionary.) It can consist of coin, paper currency, bills of exchange, commercial paper — or anything else people will accept as a medium of exchange. That's it. The problem seems to be that money is so simple a thing that people just naturally have to make it more complicated.

Consequently, there is a wide variety of views on money, especially paper money, that wander rather aimlessly between two extremes. At one end of the spectrum are people who hold that all paper money, credit cards, checks, and so on, are bad, in and of themselves. The only real and lawful money is gold, silver, and (sometimes) copper and bronze, refined, weighed, and stamped by the government into coin of the realm.

At the other end of the spectrum we find the people who are of the opinion that official State-issued paper currency is the only lawful money. People who hold this position claim that the best way to supply the nation with money is to have the government print and spend it into circulation, backed by the general wealth of the country. This is a particularly easy method, by the way, of transferring wealth from current owners, to issuers and holders of the newly issued currency.

Anyone familiar with basic principles of sovereignty that underpin western civilization will instantly see the problem. Backing the currency — often erroneously construed as the whole of the money supply — with the general wealth of the economy assumes as a given that the State has some kind of claim on that wealth. That is, the State is the ultimate owner of everything that exists. This is because money is a derivative of wealth, a symbol, a means of conveying a property right. (Irving Fisher, The Purchasing Power of Money. New York: Macmillan, 1931, 4.) The issuer must, therefore, have ownership of whatever it is that backs the money he, she, or it issues. To issue money that is not backed by anything owned directly by the issuer is theft.

Thus, defining "money" as limited to that which is issued or authorized by the State, and backed only by the State's promise to pay is the same as saying that the State is the universal owner of everything. This is the claim made by Thomas Hobbes in Leviathan. That is, a subject only holds what he or she owns against other subjects. Against the ruler, the subject is absolutely helpless. (Leviathan, II.29.) This is a basic tenet of the divine right of kings as well as socialism. It is the antithesis of democracy, to say nothing of abolishing private property to all intents and purposes. (Vide Karl Marx and Friedrich Engels, The Communist Manifesto. London: Penguin Books, 1967, 96.)

True Principles of Money and Credit

Principles of sound money and credit lie beyond these extremes. It isn't necessary, for instance, as the "gold bugs" maintain, for a currency to be the actual asset that it represents or in terms of which it is valued or measured. Nor is it a good idea to issue inconvertible currency with no direct tie to specific assets, as the populist position often advocates. That would destroy the institution of private property as effectively as direct confiscation by the State. As long as the present value of existing or future marketable goods and services stands behind a paper or token currency, however, it will generally be sound.

Thus, a gold or silver currency or paper backed 100% with gold or silver is perfectly acceptable as long as any increase or decrease in the gold and silver supply matches the present value of existing and future marketable goods and services in the economy. The Spanish discovered the falsity of the illusion that gold and silver are automatically sound money when the flood of precious metals came in from the New World after the discovery of America. The abundance of specie (gold and silver) caused a 400% inflation rate in the 16th and 17th centuries. (Sir Archibald Alison, cited by Norman Angell, The Story of Money. New York: Frederick A. Stokes Company, 1929, 131. NB: Angell cited Alison to disparage the idea that the quantity of gold had any effect on the price level, and to dismiss the possibility that the simultaneous increase in gold and silver, and the quadrupling of the price level were in any way connected.)

At the other extreme, Germany's currency at the beginning of World War I was backed by gold, and commercial, industrial and agricultural paper rediscounted by commercial banks at the Reichsbank and convertible on demand to gold. Germany's currency was considered the soundest in Europe, and the financial system of the Second Reich, copied throughout Europe, provided the model for the United States Federal Reserve System. (Moulton, Financial Organization and the Economic System. New York: McGraw Hill Book Company, 1938, 343-344.) When Germany's domestic war debt came due after the war and reparation payments were made, however, the gold and productive-asset backing were removed and replaced with the government's mere promise to pay. This precipitated the disastrous hyperinflation of the 1920s.

With these examples in mind, the principles become clear. A sound currency requires backing by a private property claim on the present value of actual, existing assets or the present value of productive assets to be brought into existence with any newly created money. A stable currency requires that the financial institutions of an economy be structured in a way that allows proper management of the money supply. Anything that circulates as money — coin, paper currency, bills and notes (whatever is used to carry out transactions and settle debts) — must increase or decrease to match the present value of the assets that back the currency. Money is clearly a derivative of the present value of existing and future production of marketable goods and services.

Money, Currency, and Banks

"Money," however, is not simply currency. In fact, coin and currency typically make up the smaller part of the money supply. In Jacksonian America, Congressman George Tucker demonstrated that the bulk of the money supply in his day, possibly as much as 90% or more, was not in the form of coin or banknotes at all. (George Tucker, The Theory of Money and Banks Investigated. Boston, Massachusetts: Charles C. Little and James Brown, 1839.) Most money was in the form of bills of exchange and other credit instruments — "mercantile paper." By the first decade of the 21st century, this "non-currency" money, or money issued directly by individuals and businesses in the private sector, still accounted for approximately 60% of the money supply in the United States, even with the growing intrusion of the State into the economy. Most money does not "look" like what most people think of as money. The greater part of the money supply never sees the inside of a bank, or even goes near Wall Street.

Such "private sector money" generally requires that the two parties to a transaction have some basis for trusting each other, or the money will not be accepted. If the individual or institution that issues the pledge is trusted ("and Scrooge's name was good upon 'Change, for anything he chose to put his hand to" — Charles Dickens, A Christmas Carol, "Stave I."), no bank or State need ever get involved. A derivative issued by someone with good credit — a "real bill" — circulates as money as readily as the official currency.

If the parties to a transaction don't know or trust each other, however, or if one of the parties wants "cash money" right away, they can use the services of a commercial bank. A commercial bank is a type of "bank of issue." A bank of issue operates in accordance with the "real bills doctrine." The real bills doctrine is that the money supply can be increased or decreased without inflation or deflation as long as the increase or decrease in the money supply matches the increase or decrease of the present value of existing and future marketable goods and services in the economy. Instead of dealing directly, the parties use the bank to intermediate the transaction, substituting the established faith and credit of the bank for that of the two parties. For providing this service the bank takes a fee, or "discounts" the paper. A bill can generally be rediscounted any number of times before the due date, at which time it must be presented to the issuer for redemption.

Sometimes these private promises circulate even more readily than official currency, if the State's credit is bad. This was the case during the hyperinflation in Germany, Austria, and Hungary following the First World War. Unofficial privately issued tokens called Kriegsgeld and Notgeld took over much of the burden from the grossly inflated official currency for daily transactions (Courtney L. Coffing, A Guide and Checklist of World Notgeld, 1914-1947, and Other Local Issue Emergency Monies. Iola, Wisconsin: Krause Publications, 1988), while real bills denominated in quantities of goods or foreign currencies instead of the national currency were used between individuals, businesses, and internationally for larger transactions.

Having a recognized and presumably secure value, such pledges can be transferred from individual to individual, or from institution to institution (discounted and rediscounted), until they mature and can be redeemed for the marketable goods or services that backed them. As we saw, to provide ready cash for someone's or something's daily transactions demand for cash, an individual or a business can take such a pledge to a financial institution and discount (sell) it to a financial institution. This is the function of a commercial bank. "Currency" is thus a derivative of money, which is itself a derivative of the present value of existing or future marketable goods and services.

Banking Operations

Formerly, a commercial bank would purchase — "discount" — a bill by creating a demand deposit or printing banknotes — issuing promissory notes. The commercial bank was also known as a "bank of circulation" (which means the same as "bank of issue"), when it issued banknotes instead of being restricted to creating demand deposits. The commercial bank would secure (back) the demand deposit or banknote by taking a lien on the present value of the marketable goods or services that the real bill represented.

Today, commercial banks in the United States and just about everywhere else no longer have the right to issue banknotes, although they are still technically classified as banks of issue. (Vide Charles A. Conant, A History of Modern Banks of Issue. New York: G. P. Putnam's Sons, 1927.) Commercial banks carry out their business through the creation of demand deposits, backed by a lien on the present value of an existing or future marketable good or service and secured by collateral to insure the loan. (Vide John Fullarton, On the Regulation of the Currencies of the Bank of England. London: John Murray, 1845, 29.)

As the system currently operates, a commercial bank cannot extend loans beyond the restrictions imposed by the reserve requirement, regardless how good or how bad the real bill presented for discounting may be. This unnecessarily ties new capital formation to existing accumulations of savings held as reserves. If, for example, the reserve requirement is 20%, the bank must maintain reserves of twenty cents for every dollar in loans. In the United States, these reserves can be in the form of vault cash, demand deposits at the Federal Reserve, or government securities. If a bank needs additional reserves due to the amount of loans it has made, it can either borrow reserves from other commercial banks through the Federal Reserve, or borrow directly from the Federal Reserve itself.

At one time, as provided in the Federal Reserve Act of 1913, a commercial bank in need of reserves could "rediscount" real bills at the regional Federal Reserve Bank. The Federal Reserve Bank would create a demand deposit or issue banknotes to purchase the real bill. This would provide the country with an "elastic" or "flexible" currency that would expand and contract in concert with the present value of marketable goods and services in the economy. (Moulton, Financial Organization and the Economic System, op. cit, 368-374.) If the reserve requirement were 100%, all loans would have to be immediately discounted at the central bank in order to meet the reserve requirement. The quantity of money in the economy would be determined by the level of trade, that is by the actual needs of the economy, not a politician's guess as to how much might be needed artificially to "stimulate" economic growth — or hold it back.

The main difficulty with a managed currency is to structure the financial system in such a way that the money supply is both adequate and stable. In the late 17th century, John Law applied himself to the problem of providing an adequate and stable currency for a country. As a result of his experience in banking and his research, he thought he had discovered a way to provide a permanent, stable currency for a nation and, at the same time, solve the chronic problem of deflation that troubled Europe from the 17th through the 19th centuries. As Conant noted,

Scotland, which gave to the world the founder of the classical school of political economy in Adam Smith, was also the birthplace of Law, the author of "the System" which introduced the use of negotiable securities on a broad scale into France. The name of Law has been synonymous with the most reckless speculation and brazen fraud, but the bank which he founded was at the outset conducted upon conservative principles, and even the system of the "Company of the West" (Compagnie d' Occident), more generally known as the Mississippi Company, was conceived upon broad and not impossible lines before the stock was made the plaything of speculation. (Conant, op. cit., 32-33.)

Scotland and the Development of Issue Banking

Scots coinage under the Stuarts at the end of the 17th and beginning of the 18th century accurately reflected the monetary chaos plaguing most of Europe. Although the same head of State ruled England and Scotland, they had different governments and monetary systems. The currency system in Scotland was a curious amalgam of continental and English denominations. A brief survey reveals Merks (Marks), Pistoles (gold coins that were originally Spanish, but widely adopted in a number of German states), the Dollar and its fractional parts, and Pence and Shillings. (Peter Seaby and P. Frank Purvey, Standard Catalogue of British Coins, Volume 2: Coins of Scotland Ireland & the Islands (Jersey, Guernsey, Man & Lundy). London: Seaby, 1984, 79-90.) This remarkable mixture was probably the result of both cultural and political ties with France ("the Auld Alliance") that were frequently closer than those with England, a traditional enemy. Scots society and institutions would thus tend more toward continental models than English.

Regardless of the variety of denominations, however, Scots coinage was insufficient for the needs of commerce. This was the driving force behind the development of the Scots land bank concept — the need to supply commerce and industry with the tools to carry out economic activity: money and credit. The key to understanding a monetary system is to realize that government, per se, does not "create" money.

Traditionally, with a specie currency the State purchases precious metal and forms it into coin at full metal value as a public service, sometimes minus a small percentage known as "agio" or "seniorage" to cover the costs of minting. ("Free coinage" does not mean that the State turns bullion into coin free of charge, but that an individual can have as much bullion as he wishes turned into coin, without limit.) As every coin collector and financial historian knows, however, it wasn't long before governments discovered the delightful possibilities inherent in putting substantially less than the full value of precious metal into a coin. This gives the illusion of a profit generated on every coin.

There is no genuine profit, however. What happens is a transfer of value from the erstwhile possessors of currency-denominated wealth (usually the poor and middle class) to the issuer of the currency that always occurs with inflation. Even today governments adhere to the myth that the difference between the face value of a unit of currency and what it costs to produce the currency represents a profit. Not so. Seniorage sets up a liability that should be redeemed for the value represented on the face of the currency at the time it was issued, or there will be an "inflation tax" levied on the citizens of the country and all users of the currency.

Fortunately, the Scottish banks understood this concept, at least with respect to paper money. They did not make the mistake of assuming that they were somehow increasing wealth by the mere fact of printing currency. Otherwise, Scotland and the rest of Europe would have experienced much worse deflationary/inflationary swings than they already had due to a lack of sufficient sound currency.

Issue Banking

The basic theory behind a "Bank of Issue" (or "Bank of Circulation"), as a financial institution that issues promissory notes and emits banknotes is called, is relatively simple. Someone with a financially feasible project comes forward to obtain a loan to float the enterprise. He could, of course, as some people do now with "regional currencies," go around and convince everyone in the community to accept what amounts to his note of hand — his IOUs. That would be difficult, however. The arrangement would have to include whatever laborers he hired, partners, suppliers, customers, and anyone engaged in commercial activity in the area where his notes might circulate. Such a private system falls apart the first time anyone refuses to accept the notes in payment of a debt.

It is much easier for an individual who requires financing to go to a bank of issue, most familiar to us today in the form of a commercial bank. Today's issue banks do not typically print banknotes, however — although two Scottish banks still retain the privilege. Instead, commercial banks issue promissory notes and create demand deposits, which serve the same purpose.

The loan officers of the issue bank presumably subject the loan request to the necessary "due diligence." If all requirements of a sound loan are met, the bank prints the currency and hands it over to the borrower. The bank takes a note as security and backing for the newly printed currency. What happens is that the bank takes the individual purchasing power of the projector (as entrepreneurs used to be called), and "generalizes" it so that it can pass current wherever the bank's promissory notes are accepted in commerce. The bank instead of the individual stands behind the IOU. This presumably makes the promissory note more secure and safer to accept in a transaction.

Any charge on the loan represents the bank's profit for performing this service plus a "risk premium" for the bank's self-insurance for bad loans. Agio is the same principle applied to coinage. As a public institution, of course, a mint should never show a profit as a result of carrying out its primary function of supplying metallic currency. Any such profit is, as noted above, just an inflationary tax on anyone who accepts the coin at face value at the time of issue.

As the loan is repaid, ideally in notes drawn on the issuing bank, the bank receives back its own notes, its "generalized IOUs," and destroys them. Thus, in the best situation, this creates a stable, asset-backed currency that expands and contracts as needed to supply the needs of commerce. (The potential for abuse, however, should be obvious to anyone familiar with the experience of the United States with "wildcat banking" before the National Bank Act of 1864.) The Scottish land banks accepted only land as security for the loans they made and as backing for the currency they printed. They thus linked the issuance of new money to what they perceived to be the most solid and secure productive asset in existence, although a severely limited one. As everyone knows, "they" aren't making any more of it.

Sometimes the returned notes were held in the bank until someone with a financially feasible project requested another loan, eliminating the necessity and expense of printing additional banknotes. Most banknotes, however, were usually canceled. This makes acquisition of specimens of such early paper currency extremely difficult. Evidence of a successful and well-managed paper currency is represented by the fact that few specimens remain. Either they were canceled and destroyed, or worn out in circulation, returned and replaced with new notes, and destroyed. In general, only poorly managed or worthless early paper currency is readily available to students and collectors.

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Out of the Depths, Prologue

A small error in the beginning, so Aristotle tells us, can lead to great errors in the end. Nowhere is this more evident than with the uniquely social goods of money and credit. Few institutions are so basic to civilization, and yet few are so widely misunderstood. Take, for example, the Congressional debates in the early 1970s over the Proprietary Fund for Puerto Rico.

Binary Economics

The "Proprietary Fund" was an application of the principles of binary economics. Binary economics is a school of economics that puts the dignity of the human person and the needs of the individual at the center of economic activity. Binary economics is based on the three principles of economic justice presented in two books by Louis Kelso and Mortimer Adler, The Capitalist Manifesto (New York: Random House, 1958) and The New Capitalists (New York: Random House, 1961). The three principles of economic justice are 1) Distribution, 2) Participation, and 3) Harmony or "social justice." (The Capitalist Manifesto, op. cit., 66-86.)

The "Principle of Distribution" is that, just as the creation of new money must be tied directly through the institution of private property to the present value of existing and future marketable goods and services, everyone who participates in the production of wealth should receive a share of the production proportionate to the value of his or her input to production. (Ibid., 67.) This is simply the application of the requirements of "distributive justice" as defined by Aristotle (The Nichomachean Ethics, V.vi) and Thomas Aquinas (Summa Theologica, IIa IIae q. 61 a.2). The consistency of binary economics with Aristotelian and Thomist philosophy is due to Adler, considered the greatest American Aristotelian of the 20th Century. Adler specifically credited Kelso with the revolutionary breakthrough that provided the theoretical basis for binary economics. (The Capitalist Manifesto, op. cit., ix.)

The "Principle of Participation" is that everyone has a "natural right" to life, which necessarily means that everyone has a right to maintain and preserve his or her life by all legitimate means — especially the right to obtain subsistence by participating in the production of wealth, individually or in free association with others. A "natural right" is a right that human beings have simply because they are human, and which necessarily defines them as "persons."

In other words, "natural rights" define us as human beings, "natural persons," and we cannot be considered fully human or human at all if our natural rights are not secured and protected. The most important of the natural rights include (but are not limited to) life, liberty (free association), access to the means of acquiring and possessing private property (especially in the means of production), and the acquisition and development of virtue (the "pursuit of happiness") (Aristotle, Ethics, op. cit., I.ii). Pursuing happiness — acquiring and developing virtue — requires power, and the most effective, even necessary means of empowerment is direct private ownership of the means of production. (Aristotle, The Politics, I.iv.) Acquiring and developing virtue is important because virtue, from vir, "man," signifies "human-ness." By acquiring and developing virtue we become more fully human.

The "Principle of Harmony" is that when our institutions become distorted or ineffective to the point that they no longer assist us in acquiring and developing virtue, we must organize, restructure our institutions, and bring these institutions back into reasonable conformity with the demands of the natural law. Kelso and Adler called this the "Principle of Limitation." (Ibid., 68.) This is because when one individual or a small group monopolizes ownership of the means of production, as in classic capitalism or socialism, the system must be reformed so that the amount of additional wealth that the monopolists can acquire is limited. In this way others can have equal opportunity to acquire and possess private property in the means of production. This conforms to the "laws and characteristics of social justice." (Vide William J. Ferree, Introduction to Social Justice. Arlington, Virginia: Center for Economic and Social Justice, 1997.)

There is, of course, much more to this. What we have here, however, is enough to understand the principles underlying the proposal for the Proprietary Fund for Puerto Rico. Interested readers may want to go to Chapter 5 of The Capitalist Manifesto (op. cit., 52-86) for a more in-depth treatment of the subject.

The Proprietary Fund

On June 8, 1972, Senator Fred R. Harris of Oklahoma had certain previously published comments by Nobel Laureate Dr. Paul Samuelson inserted into the Congressional Record. This was in support then-Governor Luis Antonio Ferré of Puerto Rico's proposal to create the Proprietary Fund that would assist the people of Puerto Rico in becoming owners of corporate equity.

Senator Harris did not suffer from the illusion that Dr. Samuelson supported expanded ownership or the ideas of Louis Kelso. No, Senator Harris believed that Dr. Samuelson, while he failed to state any specifics, did raise some "hard points" that Louis Kelso should be prepared to answer. As the Senator commented,

The Ferré proposal soon gave rise to an exchange of views between noted economist Paul Samuelson and Kelso. Although the exchange is perhaps more polemical than a real examination of the problem would require, it is instructive.

In the case of Samuelson, despite hard points which Kelso must answer, we see again the unwillingness to face up to the problem of the distribution of wealth. Nowhere in Professor Samuelson's contribution is there any concern expressed over the extremes in wealth ownership on the island of Puerto Rico.

In the case of Kelso, whatever we may think of his recommendations, we have a man who at least is talking about an important problem. I am not judging his scheme one way or another. Neither man goes into sufficient detail for an outsider to judge the logical rather than the polemical face of the argument. Nevertheless, I rather feel Kelso won the exchange and for this reason. If his scheme is economically faulty as Samuelson suggests, then I agree with a point Kelso has made repeatedly, namely that the more established economists should come forward with a scheme which is not faulty. For the problem of such gross disparities in ownership is a real one. It will not go away because our more established economists ignore it. (Congressional Record — Senate, June 8, 1972, S 9053.)

On reading Dr. Samuelson's remarks after the passage of nearly four decades and the repeated failure of the Keynesian economics to which the Nobel Laureate devoted his entire career, the objective reader is struck by one thing, as was, apparently, Senator Harris. Whether or not one happens to be an economic "insider," there appears to be a profound lack of substance in Samuelson's arguments. As seems to have been habitual with Dr. Samuelson, he relied exclusively on appeals to authority, elitism, and innuendo.

For example, at one point Dr. Samuelson claimed that "it would be rash" for low-income families to become capital owners by borrowing money and repaying the acquisition loan out of the profits generated by the capital itself. Financial feasibility of this type is the first principle of corporate finance, or how the rich have always become richer.

Dr. Samuelson, however, claimed that the first principle of sound finance is not financial feasibility — that is, whether capital can pay for itself — but that "families at low income levels must not invest so heavily as more affluent families in venture equities." (Ibid.) In other words, in Dr. Samuelson's understanding of finance, the most important thing is that poor families must not be permitted to lift themselves out of poverty through access to the means of acquiring and possessing private property in the means of production.

Besides, who said anything about poor people investing in "venture equities"? The "Kelso Plan" was to provide a means whereby ordinary workers could purchase shares in the companies that employed them on credit without the use of existing accumulations of savings. Nothing was ever said about poor people putting their non-existent savings into "venture equities" in untried startup companies. Very much the contrary — Kelso's idea was that workers would be empowered to purchase on credit the tools with which they worked to gain a living income, not gamble in high risk IPOs or speculative equity issues on Wall Street.

Nor is a "first principle of sound finance that families at low income levels must not invest so heavily as more affluent families," anyway. According to financial historian Benjamin Anderson, "The first principle of commercial banking [is] to know 'the difference between a bill of exchange and a mortgage'." (Benjamin M. Anderson, Economics and the Public Welfare: A Financial and Economic History of the United States, 1914-1946. Indianapolis, Indiana: Liberty Fund, Inc., 1980, 233.) That is, the first principle of finance is to know the difference between a financial instrument drawn on the present value of existing and future marketable goods and services, and a financial instrument drawn on a consumer item that does not pay for itself. Others declare that the first principle of finance is that whatever capital is purchased must pay for itself out of its future earnings: "financial feasibility," or employing a "cost/benefit analysis." (Vide Sukhamoy Chakravarty, "Cost-Benefit Analysis," The New Palgrave: A Dictionary of Economics, Vol. 1. New York: W. W. Norton, 1989, 687-690.) These are, frankly, just two different ways of saying the same thing: that capital should pay for itself out of its own future earnings.

The "dangers" of low-income people purchasing the tools with which they work and by means of which they earn their incomes on credit without using existing savings do not appear to be mentioned in financial literature. Dr. Samuelson appears to have tailored the declaration out of whole cloth. The bottom line, however, is Dr. Samuelson's implicit assumption that capital formation cannot be financed except through the use of existing accumulations of savings, that is, by cutting consumption. Naturally, poor families cannot save without extreme hardship. This assumption (disproved by Dr. Harold G. Moulton in his landmark treatise, The Formation of Capital. Washington, DC: The Brookings Institution, 1935) pervaded Dr. Samuelson's testimony.

Samuelson v. Kelso

Nor was this an isolated incident. Dr. Samuelson, in fact, appeared to have a special animus against Kelso — not that it ever led to Dr. Samuelson saying what, specifically, was supposed to be wrong with binary economics or expanded capital ownership. This was demonstrated a few years later when Mike Wallace of 60 Minutes interviewed Dr. Samuelson to get his comments on Kelso's ideas. Evidently Dr. Samuelson was starting to feel pressured, for he was even more dismissive of the ideas than he had been previously. The Nobel Laureate changed his reasons for rejecting the ideas, but not his negative assessment:

Mike Wallace: All right. My understanding of Kelso-ism is that it's designed to enable men who are born without capital to buy it, to pay for it out of the income it produces, to own it and thereafter to receive income from that capital. Devoutly to be wished!

Paul Samuelson: Oh, yes. And it would be nice to have lollipops grow on trees for the picking.

Mike Wallace: The only thing that you object to, really, in Kelso-ism is the fact that it uses a tax loophole to give the workers stock in the company?

Paul Samuelson: That is my primary criticism. Now, you tell me that Senator Long is interested in this. I'm distressed. I'm distressed because Senator Long is an influential Senator in connection with the closing of tax loopholes and the opening of them. ("A Piece of the Action," 60 Minutes, with CBS News Correspondent Mike Wallace, Produced by Norman Gorin, aired on March 16, 1975.)

First, of course, Dr. Samuelson's "primary criticism" in the intervening years changed from concern for the poor workers who cannot afford to fit themselves into the false assumptions of modern economics by cutting consumption and saving, to concern over the manipulation of the tax system. This is a somewhat ambiguous position for a Keynesian to take. Second, it is difficult to see how wishing for lollipops to grow on trees for the picking has anything to do with binary economics.

Even more odd, Russell Long's support for the ESOP was, by this time, well known. It is hard to believe that Dr. Samuelson was unaware of Senator Long's key support for the ESOP until Mr. Wallace informed him of it on national television. Long's support ensured that Kelso's proposal had been inserted into the Employee Retirement Income Security Act of 1974 on January 1, 1974. This was more than a year before Mr. Wallace interviewed Dr. Samuelson (vide Norman G. Kurland, "Dinner at the Madison," Owners at Work, Ohio Employee Ownership Center, Kent State University, Winter, 1997-1998). The only way to understand Dr. Samuelson's position (as well as his denial of obvious and provable facts) is to realize that Dr. Samuelson was absolutely convinced that the science of finance is irrevocably wedded to dependence on existing accumulations of savings.

Samuelson on France

Nowhere was Dr. Samuelson's lack of understanding of money, credit, and banking (to say nothing of private property) more evident, however, than in his confused comments on early 18th century France. As Dr. Samuelson related in the passages Senator Harris inserted into the Congressional Record in 1972,

You cannot get something for nothing in economic life. The scandal of John Law in ancient France pretended otherwise, and led to fiasco. I fear the same in this case. If the Commonwealth guarantees bank loans to purchase Patrimony stocks, it has thereby less credit to expend in other directions of development. What advantage is there in a dollar of dividends if it slows down the growth of productivity of real wages by tens of dollars? (Statement by Paul A. Samuelson on House Bill 1708, concerning the Patrimony for the Progress of Puerto Rico, "the Proprietary Fund," Congressional Record, loc. cit.)

The fractured syntax supports Kelso's otherwise uncalled-for observation that Dr. Samuelson seemed to have turned the task of writing his critique of binary economics over to one of his students. How, for example, does a scandal, even unspecified, pretend anything? What on earth did Dr. Samuelson mean by "the growth of productivity of real wages"? Those statements in this brief passage that are not incomprehensible are misleading. There is enough sly innuendo inserted to boggle the mind of anyone who has managed to free him- or herself from the disproved Keynesian dogma that only existing accumulations of savings can be used to finance capital formation. As the subtitle of The New Capitalists, the second collaboration of Louis Kelso and Mortimer Adler, puts it succinctly, "A Proposal to Free Economic Growth from the Slavery of Savings."

Who, however, was this "John Law" whose "scandal" — according to Dr. Samuelson — led to "fiasco" in "ancient France"? And what, exactly, was this scandal to which Dr. Samuelson referred, and how did it lead to fiasco?

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A More Just Tax, Part IX: Freedom from the Slavery of Savings

By Norman G. Kurland, Dawn K. Brohawn, and Michael D. Greaney

In the previous posting we decided that a single tax rate of 50% on all income from whatever source derived is reasonable given the colossal debt problem — meaning that it would be bearable if imposed on incomes of over $30,000 for a non-dependent and $20,000 for a dependent. We can, however, expect that individuals in the upper brackets will protest that the bulk of their income derives from dividends and capital gains, which are usually taxed at more favorable rates than wage incomes. This is to encourage reinvestment of corporate profits in order to finance economic growth and provide wage system jobs. The income from these jobs can then be taxed instead of dividends and capital gains. Is that, however, the most efficient and cost-effective means of financing more universal participation in economic growth and capital formation?

Not according to Dr. Harold Moulton in his classic 1935 study of financing investment, The Formation of Capital. As we pointed out in the previous posting, by cutting consumption (which is what, effectively, reinvestment is), economic growth is slowed dramatically. In extreme cases, where money is created for non-productive uses and reinvested in speculation or gambling (as was the case in 1929 and again in the recent economic "downturn"), the resulting "readjustment" in the economy can be devastating in its effects.

For comparison, let's first assume that Capital Homesteading will not decrease the Federal budget at all, and that the single tax rate is 50%. Further assume, however, that the personal exemption plus deductions is $30,000 per non-dependent, and $20,000 per dependent, that corporate dividends and inflation-indexed capital gains are taxed once as ordinary income at the individual level, and not at all at the corporate level (i.e., dividends are tax deductible), and — this is very important — social units such as families can aggregate their exemptions and deductions.

Even without reductions in the Federal budget, the effective tax rate on incomes of less than $150,000 would be under 16-2/3% — substantially less than now — while the effective tax rate on income of $1 million would be 45%. Still, an effective rate of more than 45% on incomes of $1,000,000 or more is pretty high. It is much higher than the approximately 15% rate often paid on qualified dividends and capital gains. Taxes on dividends and capital gains are a political football, depending how well the government juggles the growing need for cash against the illusion of the need for past savings to finance capital formation. In any event, wage income above $1 million is relatively rare, and most people with incomes at that level receive it in the form of dividends and capital gains — on which they receive extremely favorable tax treatment, when they are taxed at all.

We have to take into account, however, the actual "double taxation" of dividends and the effective double taxation of capital gains. The effective double taxation of capital gains is a reflection of the value of retained earnings, which represent undistributed corporate income on which taxes have been paid. Given the usual double taxation, is the favorable tax treatment for dividends and capital gains all that "favorable"? Looking at how dividends and capital gains are currently taxed for a single individual gives a somewhat different picture. Assuming a 15% tax on dividends and capital gains and a 35% tax on corporate profits, we get a 50% total tax rate on dividends and capital gains — which is the same rate we have provisionally calculated for all income under a Capital Homesteading single rate tax. For the wealthy, then, Capital Homesteading would be "tax neutral," while it would substantially lower taxes for the non-wealthy.

These figures do not materially change when we factor in the current level of personal exemptions and the standard deduction. Many rentiers (small investors) do not qualify for itemization if they've been financially prudent. The figures do, however, increase if we factor in a corporate tax rate greater than the 35% minimum we used in the calculation. The "favorable" tax treatment under the current double- and triple-taxation is not quite as "favorable" as many people suppose. Finally, if we remove the extremely unpopular favorable tax treatment of dividends and capital gains and tax such income at the highest marginal rate of 35%, adding that 35% to the 35% corporate tax levied on corporate income in excess of $18.3 million results in an effective tax rate on the wealthy of 70% — certainly more than the proposed estimated 50% single rate under Capital Homesteading.

Reducing the Federal Budget: Looking Forward to 2050

All of the above assumes as a given that the current estimated federal budget will not decrease in any way; that any decreases in expenditure will be applied to reducing the debt or meeting the estimated $74 trillion shortfall in Social Security and Medicare. We have to keep in mind, however, that the income generated by individual Capital Homestead Accounts will at first supplement, and eventually replace virtually all transfer payments, Social Security, Medicare, and other entitlements, and that the personal exemption and a negative income tax (or vouchers) will be taking care of education and health care. Private charity will be able to handle much of what remains in hard cases, so that government welfare and entitlements will diminish to the absolute minimum necessary to maintain an emergency "social safety net."

Our previous example assumed that only half the entitlement budget would disappear, but within two generations, all current promises will have been kept, and former entitlements will have been changed to rare emergency payments to help those rare individuals whose Capital Homestead Accounts have failed to generate sufficient income to meet the greatly increased tax exempt income. It may not be too much of a coincidence that the potential reduction in the federal budget achieved by eliminating entitlements — $2 trillion — is approximately equal to the annual "growth ring" of new capital added to the U.S. economy.

This suggests that widespread ownership through Capital Homesteading has the capacity in and of itself to cover the Social Security, Medicare, and all other entitlement budget shortfalls. It is also consistent with former U.S. Comptroller David Walker's statement that entitlements make up two-thirds of the federal budget. We need, however, to add in a provision for the negative income tax, whether in the form of direct cash payments or vouchers. Realistically, this would be taken care of by the increase in the tax base combined with decreases in federal spending, but we are, again, being as conservative as possible.

Assuming that the average income below the new individual "poverty level" ("Subsistence Level Necessary to Meet Common Domestic Needs Adequately" would be a more accurate description, but "Poverty Level" is embedded in the public mind, and needs no lengthy explanation.) of $30,000 (the amount of the personal exemption) is exactly half of the new poverty level gives us $15,000. This means that an additional $15,000 would be needed on the average for each person in poverty to bring him or her up to the poverty level. According to the Census Bureau, 37 million Americans live in poverty, which we will round up to 40 million.

Obviously, increasing the "poverty level" to $30,000 would, in and of itself, vastly increase the number of Americans living in "poverty." This is offset by the fact that the Federal Reserve Board estimated total consumer debt as of 9/30/07 at $2.482 trillion, or approximately $8,000 per capita. (Recent news reports indicate that this has increased to $9,000, but this has not been verified.) Adding in mortgage debt (characterized by former Federal Reserve Chairman Alan Greenspan as a "bubble") of $3.001 trillion gives an additional $10,000 of per capita debt, much of which was revealed to exceed the value of the homes on which the mortgage was made.

In effect, each American family of four has a debt burden of $72,000. We are forced to conclude that families are spending far beyond their actual incomes, and are already effectively, if not officially, living in poverty. The needs of these individuals and families are being met out of non-existent savings (increases in debt) or by various forms of State welfare or redistribution.

Taking only the "non-revolving" consumer debt figure of $1.5 trillion supplied by the Federal Reserve for September of 2007 (ibid.) ("non-revolving" meaning debt that must be paid in the current period, and not renewable, or "revolving"), gives a per capita amount by which each individual lives beyond his or her means each year of $5,000 ($20,000 for a family of four). Subtracting $5,000 from the basic exemption of $10,000 plus the health care deduction of $7,000, and assuming that there are no education expenditures or Capital Homestead investment gives $12,000. This amount is close to the current "poverty level" of $9,973 for an "unrelated individual," and slightly under the $12,755 for a "Family of Two."

This suggests that our Capital Homesteading reforms will not appreciably increase, and should even reduce the number of persons under the "poverty level" even as the "poverty level" is dramatically increased. This will be accomplished by allowing individuals and families to meet common domestic needs adequately without such pervasive recourse to consumer debt.

A significant amount of this "increased" income (actually taxes that are not paid until income from all sources exceeds $30,000) will result from folding Social Security and Medicare taxes — currently at around 15% (Currently individuals pay half, or approximately 7.5% of the Social Security and Medicare tax, while employers pick up the other half. By folding Social Security and Medicare into the general tax rate on individuals, employers will no longer be charged the other half of Social Security and Medicare taxes. This will free up profits to pay out as dividends, or increase wage incomes, both of which would increase consumption incomes under Capital Homesteading.) — into the general, single tax rate, and not on all wage income below the existing statutory limit. This will mean an effective increase in consumable income of $4,500 on wage incomes of $30,000.

Multiplying our new "half poverty" level of $15,000 by 40 million persons gives us an "add back" to the Federal budget of $600 billion in negative income taxes. We round this down to $500 billion due to the fact that we originally rounded up the number of people in poverty. We also did not take into account that there are probably no individuals receiving absolutely no income, and, as the economy gears up for full production, far fewer people will receive the negative income tax, and those in decreasing amounts as personal income rises with the creation of jobs in a fast-growth economy combined with increased capital income from Capital Homestead Accounts.

Adding $500 billion back into the reductions of $2 trillion leaves us with a rough estimate of the Federal Budget under Capital Homesteading of $1.5 trillion — half the anticipated budget before the current bout of mega-spending on bailouts and stimulus. Using these new figures to calculate the single tax rate once Capital Homesteading has empowered individuals and families to accumulate a significant amount of income-generating assets (less than 40 years, given the anticipated increase in economic growth) gives us $1.5 trillion divided by taxable GDP of $6.3 trillion, or 23.81%. This is a much more palatable figure, less than the current corporate tax for larger businesses, or the individual marginal tax rate of persons in the higher brackets — and remember that if a family of four pays no taxes on aggregate income of less than $100,000, paying taxes at all means a family is already in what is today regarded as a "higher bracket" before it begins paying taxes.

If it were possible to eliminate all welfare (an unrealistic expectation, of course), we would have a tax rate calculated by dividing $1 trillion by $6.3 trillion, or 15.87%. Still, being able within a generation to reach the hitherto "unreachable star" of full employment by including full employment of capital combined with widespread ownership thereof, should eliminate poverty as a permanent condition of life for an estimated 13% of Americans, leaving the negative income tax to succor the truly unfortunate, instead of trapping people into an unbreakable cycle of poverty.

This version of the single rate tax represents a revolutionary restructuring of the Welfare State based on class warfare and redistribution, to a welfare state based on the economic empowerment through capital ownership of every citizen as a fundamental right of citizenship and self-governance. This, of course, would make the State more dependent on the citizens, rather than having the citizens increasingly dependent on a "Big Brother" form of government.

A tax rate of 23.81% is, however, still a high figure — but what does it really mean? The median income in many states today is below $40,000, according to the Census Bureau (the average median income of all 50 states, the District of Columbia, and Puerto Rico is a little over $68,000), so what would the real or "effective" tax rate be? Let us assume that people making less than $100,000 take all their income in the form of wages. This is actually not too unrealistic, for most middle class investors do not spend any dividend and capital gain income, choosing to reinvest what they might have for retirement.

Let us further assume that, in an attempt to meet the present value of the projected shortfall in Social Security and Medicare, the $74 trillion or so (Thomas R. Saving, "$74 Trillion = Crisis", The Wall Street Journal, March 9, 2005, A20. Mr. Saving, a senior fellow at the National Center for Policy Analysis, is the director of the Private Enterprise Research Center at Texas A&M.) will be raised (or will try to be raised) by levying the approximately 15% tax on all wage income up to $100,000, of which the employer pays half, or 7.5%.

The Goal: Effective Tax Rates Under the Proposed Capital Homestead Act

Now we compare today's taxes with what would be paid after the system has been in place for a generation, assuming that the Capital Homestead reforms are adopted in their entirety. Assuming a family of four, the aggregation of personal exemptions, a single personal tax rate of 23.81%, — rounded up to 25% — and Social Security and Medicare merged into the general single tax rate, a four-person families with an aggregate income of $100,000 or less would pay no taxes. Within a generation it would not be until a family had aggregate income of more than $250,000 that the family's entire tax rate would be even close to the current Social Security tax (of which self-employed individuals pay both "halves," whether they make $1 or $100,000), much less today's income tax.

The effective tax rate only gets above 20% for incomes in excess of $500,000, while someone making a million dollars in annual income would pay less than 23% — less than the current marginal tax rate of approximately 35% on wage income in that bracket, and substantially less than the nearly 70% paid on "non-wage" income in the form of capital gains and ordinary dividends once the politically and economically non-viable favorable tax treatment is removed.

Conclusion: The Goals of the Capital Homestead Act

A tax system that conforms itself to common sense and the goals of the Just Third Way embodied in the proposal for a Capital Homestead Act would, obviously, advance the goal of establishing and maintaining an economically just social order. This is the goal of Capital Homesteading and, of course, the Just Third Way. A tax system based on common sense and a minimum number of easily understood and straightforward rules and regulations intended for the sole purpose of raising revenue for the State in a manner consistent with the Just Third Way would also solve what is rapidly becoming the most overwhelming, even disastrous problem facing the world today, the colossal mountain of debt resulting from decades, even centuries of incredible financial mismanagement and counterproductive government spending. The Capital Homestead Act is designed to:

1) Generate millions of new private sector jobs by lifting ownership-concentrating Federal Reserve credit barriers in order to accelerate private sector growth linked to expanded ownership opportunities, at a zero rate of inflation.

2) Radically overhaul and simplify the Federal tax system to eliminate budget deficits and ownership-concentrating tax barriers through a single rate tax on all individual incomes from all sources above basic subsistence levels. Its tax reforms would:

a) eliminate payroll taxes on working Americans and their employers;

b) integrate corporate and personal income taxes; and

c) exempt from taxation the basic incomes of all citizens up to a level that allows them to meet their own subsistence needs and living expenses, while providing "safety net" vouchers for the poor.

The time to act is now.

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News from the Network, Vol. 3, No. 20

So far the BP oil spill and the ups and downs in the stock market are vying for the top news spot. On the surface, these look like two different issues. After all, what could be more different than gigantic financial services companies breaking the rules and messing up the economy, and gigantic natural resource extraction companies breaking the rules and messing up the ecosystem . . .

Okay, so it's the same basic problem, and the same basic situation, to say nothing of the same basic mindset, and the same basic solution: the government should do something! What should The Government (bow) be doing? Seek out the guilty! Put them on trial!! Give them the electric chair for life!!! And then get serious by passing more laws telling people not to do what is most advantageous for them to do and will generate the most profits . . . and if they lose money, the State will bail them out, or subsidize them, because they are too big to fail.

As the French say, plus ça change, plus c'est la même chose — the more things change, the more they stay the same. (No, I don't speak French ... it's just amazing what you can find on the internet.) Why? Because people are not looking at the system, but at the symptoms. Symptoms of a badly structured system are infinite, and not even the most powerful and intrusive State can create a regulation to cover every single one of them — or enforce.

For example, according to today's Wall Street Journal, Congress has just passed a bill with the "most sweeping reform" of Wall Street since the Great Depression. The Associated Press appears to concur. It is clear, however, once we look at the various provisions, that there is very little that is either effective or, frankly, realistic. The new legislation is, basically, a package of "don't do that" orders. With the sole exception of a token prohibition against banks dealing in derivatives, there does not appear to be anything addressing problems in the system.

As we already know from the laws and characteristics of social justice, simply ordering people to do what's right is a useless and frustrating exercise until and unless we make it possible for people to do what is right by restructuring our institutions to conform to universal precepts of the natural moral law. Here's what we've been doing to try and bring a modicum of common sense to the situation:

• Speaking of internal controls, Dr. Norman Kurland was as impressed with the analysis of what happened with the removal of internal controls in the financial services industry in Lydia Fisher's Cinderella of Wall Street, as he was unimpressed with the measures taken by Congress to correct a situation that they caused in the first place with the repeal of Glass-Steagall (the Banking Act of 1933) and similar internal controls. Trying to correct the problem by adding increasingly levels of external regulation and State involvement exhibits a profound misunderstanding of the role of the State. It also increases State intrusion into areas in which it has no business: business, thereby increasing the danger or (more often these days), the magnitude of the problem of functional overload of the State. The State cannot legislate morality, which is what ethics, business or otherwise, are. The State's limited role in the economy is to enforce the ethical standards and agreements, police abuses, and provide a "level playing field."

• U. S. News and World Report published an article, "12 Ways to Fix Social Security." You don't have to read the article, although we've included a link. It's not really a list of a dozen, but boils down to three simplistic options, none of which are either politically or financially feasible: 1) Pay in more (7 "ways"), 2) Pay out less (4 "ways"), 3) Use any surplus to purchase secondary issues on the stock market (1 "way"). Option No. 3, while seemingly the most fiscally responsible, is actually the most deceptive — and the most dangerous. Not only would a massive infusion of government funds drive up prices on the stock market, but it would give the federal government a significant direct ownership stake in the private sector, complementing the enormous indirect control ("ownership") it now enjoys. Noticeably absent is the only solution that makes sense: Capital Homesteading for Every Citizen, which would be much more respectful of human dignity and personal sovereignty by returning to people direct control over their own lives.

• Early this week Norman Kurland met with Elias Chipimo, who is running for president of Zambia in 2011. Mr. Chipimo is running on an inclusionary, anti-corruption ticket and, where other candidates are trying to emphasize tribalism, Mr. Chipimo is stressing unity and solidarity. Norm reported that Mr. Chipimo has expressed great interest in implementing the Just Third Way in Zambia as a way of fostering economic growth in which every citizen can participate. Mr. Chipimo is only in the United States for a week, but wants to meet again with Norm for more discussions.

• Today Norman Kurland is being interviewed on Fairfax cable television on the applicability of the Just Third Way to the situation in the Middle East. Stressing justice and its importance to people of all faiths, Norm made a point of wearing an "Own or Be Owned" tee shirt during the interview.

• As of this morning, we have had visitors from 42 different countries and 43 states and provinces in the United States and Canada to this blog over the past two months. Most visitors are from the United States, Canada, the UK, Brazil, and India. People in Norway, Belgium, Maldives, Venezuela, and Romania spent the most average time on the blog. The most popular posting is "News from the Network," followed by "Kemp Harshman, Soldier of Justice," "Thomas Hobbes on Private Property," "Expanded Capital Ownership Now," and "The Great Society" in the "Own the Fed" series.

Those are the happenings for this week, at least that we know about. If you have an accomplishment that you think should be listed, send us a note about it at mgreaney [at] cesj [dot] org, and we'll see that it gets into the next "issue." If you have a short (250-400 word) comment on a specific posting, please enter your comments in the blog — do not send them to us to post for you. All comments are moderated anyway, so we'll see it before it goes up.

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