Thursday, June 17, 2010

Common Cause, Part II: Common Currency Pitfalls

A decade or so ago, just before the official launching of the Euro, The Wall Street Journal took a random and informal poll of New Yorkers to determine the level of recognition among the general population. The results were discouraging, even given the insularity of the inhabitants of the Island of Manhattan. Responses ranged from identifying the Euro as an ad campaign, to a new kind of perfume. The few who could identify the new currency correctly had distinct trouble with naming the countries in which it was to be implemented. (Barbara Tierney, "Very Few New Yorkers Understand Eurology, a Random Survey Finds," The Wall Street Journal, 12/29/98, B-1.)

External v. Internal Control

Ironically in light of recent events revealed by the current global economic crisis, most of the concerns expressed about the introduction of the Euro centered on how best to manage the currency. Not surprisingly, even the orientation toward managing the currency was off base. Authorities were concerned with how to prevent individual governments from running up large deficits, ensuring that proper procedures were followed, making certain that the money creation power was not abused, and so on.

In short, the orientation of the people attempting to manage the new currency was how best to impose desired results through the implementation and maintenance of measures enforced by the State, or some agency backed up with the coercive power of the State. There was virtually no consideration given to setting up the system itself to separate functions properly and maintain control over the system internally, that is, naturally. The emphasis was all on external controls enforced through coercion, not internal controls enforced by the structuring of the system.

From an administrative point of view, the main problem with relying on external instead of internal controls is that problems can be hidden much more easily under an imposed set of external controls than they can under internal controls integrated into the system. Under imposed external controls, all that is necessary is to hide the violation or the problem and hope it goes away or doesn't get discovered by the regulators.

Sometimes the problem does, in fact, go away. Unfortunately, all that usually does is convince those responsible that 1) it must not really have been a problem in the first place, and 2) it was not wrong. This can even work when the external regulatory agency (usually the State) discovers the problem. Those responsible need only convince the regulators or (if it goes that far) the judge and jury that they really did nothing wrong, or that the good they presumably did outweighed the unintended evil. The end result is that serious problems are not resolved. The situation can mushroom with incredible speed once a seemingly insignificant problem, such as securitizing toxic mortgage-backed securities, acts as a trigger setting off a cascade of failures throughout the badly structured system.

When internal, that is, systemic controls are circumvented, however, that task of resolving the problem is of necessity forced out into the open. The system does not usually work, or does not work as well, if it is not used as intended. For example, an important internal control in any business is not to have the power to authorize disbursement of cash vested in the same individual who disburses cash. Attempts by the disburser to self-authorize a disbursement, or the authority to receive cash not properly disbursed, given reasonable internal controls and separation of function, should immediately become obvious. It requires collusion to hide malfeasance even temporarily, and even that is risky if the system is audited periodically. (It is also much more difficult for two or more people to keep something like that hidden — "Three can keep a secret if two are dead.")

Reestablishing the Money Trust

Perhaps the most egregious recent instance of actively dismantling effective internal controls in favor of ineffective external controls was in the final repeal of the Banking Act of 1933 — "Glass-Steagall." Perhaps not coincidentally, this was at approximately the same time that the details of managing the Euro were being worked out. American bankers were afraid that they would not be able to compete on equal terms with the European financial services industry, a traditionally vertically integrated system that was now headed toward horizontal integration.

The American banking industry made the case to Congress that they should be allowed to integrate vertically the same way that the European banks had always done, and horizontally as the European banks were preparing to do. Legislation mandating vertical separation of function as well as laws inhibiting or preventing horizontal integration should be repealed. Chief among these laws was Glass-Steagall, which forbade commercial banks and investment banks to combine. Glass-Steagall had been enacted in the wake of the Crash of 1929 when commercial banks and investment banks operating under the same roof engaged in massive money creation (a commercial banking function) to purchase speculative issues on the secondary market — the purchase of secondary issues being a function of investment banks.

With the same institution able to create money and spend it — recall our example of basic internal control mandating that authorizing the disbursement of funds must always be separated from the actual disbursement — there was a phenomenal lack of due diligence. By separating commercial and investment banking, Glass-Steagall forced financial institutions to justify money creation and investment in a way that is not considered "necessary" when the same company carries out both functions.

The American banking industry put pressure on Congress in the form of the upcoming European common currency and the consequent creation of a monolithic European financial services industry. The bankers used the fear of lack of competitiveness of the American financial services industry to sway the legislators. The savings and loan debacle that had recently shook the country, due directly to the failure to maintain adequate separation of function and thus proper internal controls, was dismissed as an anomaly. (The specific problem in the savings and loan meltdown was "asset mismatch," caused by the savings and loans investing in areas in which they had no previous experience.) Other concerns were trivialized by asserting that the State had merely to enforce existing (external) regulations in order to ensure that everything was properly run.

The end result was the creation of an American "financial services industry" that was and continues to be both horizontally and vertically integrated. In effect, the United States returned to the conditions that prevailed in the United States in the late 19th and early 20th centuries, and that caused the "Panic of 1893" and the "Panic of 1907." The monopolistic "Money Trust" was in virtual total control of the financial system of the United States. This eventually led to the formation of the Federal Reserve in an effort to break up the concentration of control over money and credit.

Government Collusion

There is, however, a significant difference between the current situation and that of a century ago. There was no central bank in 1893 or 1907 to regulate the money supply and provide for a stable and elastic currency to meet the needs of the private sector for liquidity or provide emergency reserves in time of crisis. Instead, the National Bank system provided an inadequate means of oversight of the currency, with virtually no regulatory control over the money supply or interbank transfers.

While we now have a United States central bank in the form of the Federal Reserve System, it has been effectively subverted to serve political, rather than economic or financial ends. As a result of the expansion of government control over money and credit, power is even more concentrated than it was in 1893 or 1907, and the situation is consequently much worse. Concentrated financial power in the form of an integrated financial services industry has combined with concentrated political power vested in the federal government to create an economic leviathan, a giant with extremely unstable feet of clay. As one moral authority described the situation,
It is obvious that not only is wealth concentrated in our times but an immense power and despotic economic dictatorship is consolidated in the hands of a few, who often are not owners but only the trustees and managing directors of invested funds which they administer according to their own arbitrary will and pleasure.

This dictatorship is being most forcibly exercised by those who, since they hold the money and completely control it, control credit also and rule the lending of money. Hence they regulate the flow, so to speak, of the life-blood whereby the entire economic system lives, and have so firmly in their grasp the soul, as it were, of economic life that no one can breathe against their will. (Pope Pius XI, Quadragesimo Anno ("On the Restructuring of the Social Order"), 1931, §§ 105-106.)
This did not, of course, happen overnight. We will examine how this situation came about in greater detail later, but right now we want to know what is missing from the equation. Obviously something is lacking, or there would not have been the insane push to remove effective internal controls and replace them with an unworkable, even suicidal effort to impose desired results from the outside. As matters now stand, neither the American financial services industry nor its twin in the European Union can give a good argument for establishing or maintaining a common currency or a common government.

The greatest fear in a currency union, of course, is that the most powerful financial participant in the union will manipulate and control the other members politically. It was in this way, in large measure, that Prince Otto von Bismarck was able to exploit economic conditions to force German unification on Prussian terms and maintain the superior position. By this means Bismarck overcame the more democratic orientation of the other, less powerful members of the German Confederation. They were largely helpless before the economic (and consequently political and military) might of the northern German giant. (A.J.P. Taylor, Bismarck, The Man and the Statesman. New York: Vintage Books, 1967, 76-77; Karl Helfferich, Money. New York: The Adelphi Company, 1927, 147-174.)

Nevertheless, political or economic domination does not have to follow union. In the Latin Monetary Union, France, Belgium, Switzerland, Greece and Italy maintained currencies that passed at par for decades before the disaster of the First World War destroyed that and much more besides. Many countries in Central and South America also adopted the standard of the Latin Monetary Union in order to facilitate trade and establish sound currencies. What is the missing element to ensure, as far as humanly possible, that a currency will both remain stable, and not be used as a means of carrying out a program of monetary or even political imperialism?

Expanded Capital Ownership

The missing element that must be added to the proper structuring of the financial services industry is widespread direct ownership of the means of production. This is as Louis O. Kelso and Mortimer J. Adler pointed out in the two books they co-authored, The Capitalist Manifesto (1958) and The New Capitalists (1961).

The subtitle of the latter is significant: "A Proposal to Free Economic Growth from the Slavery of Savings." Kelso and Adler's contribution (in addition to the critical principles of economic justice on which the proposal is based) was to add that the new capital financed with expanded bank credit rediscounted at the Federal Reserve must be broadly owned in order to ensure that 1) people can provide for their own needs without massive government intervention into their private lives, 2) income will be spent on consumption instead of reinvestment, and 3) people will have an adequate and secure source of income from capital to supplement and, in some cases, replace income from labor. This last is a critical point in a technologically advanced economy. As technology improves, capital replaces labor as the predominant factor of production. The problem becomes what to do about it.

The Keynesian answer, of course, is for the State to assume direct control of the economy, largely through monetary and fiscal policy, i.e., by manipulating the currency and redistributing sufficient effective demand by direct taxation or the hidden tax of inflation. Obviously this is not working, or the global economy would not be in the mess it is in.

Unfortunately, the global financial system, as well as the monetary and fiscal policy of every government on the face of the earth, is structured on the fixed belief, even obsession that Keynes's assumption is correct: that the only way to finance new capital formation is to cut consumption, save, then invest. The fact that this has been proven wrong time and again, and that it is proved wrong every day doesn't seem to make any difference to the powers-that-be. The fallacy has acquired a status tantamount to Holy Writ — even as Keynes himself predicted, although he probably exempted himself from his blanket criticism of every other academic economist and political philosopher:
The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas. Not, indeed, immediately, but after a certain interval; for in the field of economic and political philosophy there are not many who are influenced by new theories after they are twenty-five or thirty years of age, so that the ideas which civil servants and politicians and even agitators apply to current events are not likely to be the newest. But, soon or late, it is ideas, not vested interests, which are dangerous for good or evil. (General Theory, op. cit. VI.24.v.)
The proper thing to do with bad ideas, however, is not to force people to go along with an even worse idea based on misplaced faith in some panacea or personal interpretation of a new edition of some presumably holy scripture. Bad ideas can only be replaced by good ideas, discerned through the use of reason, not faith, presented in a logical and rational manner, and supported with hard evidence, not sneers and ridicule. As one of the most logical thinkers who ever lived put it when faced with an irrational interpretation of reality based on faith instead of reason,
Behold our refutation of the error. It is not based on documents of faith, but on the reasons and statements of the philosophers themselves. If then anyone there be who, boastfully taking pride in his supposed wisdom, wishes to challenge what we have written, let him not do it in some corner nor before children who are powerless to decide on such difficult matters. Let him reply openly if he dare. He shall find me there confronting him, and not only my negligible self, but many another whose study is truth. We shall do battle with his errors or bring a cure to his ignorance. (St. Thomas Aquinas in response to Siger of Brabant's attempt to base the law on faith rather than reason. Quoted in G. K. Chesterton, Saint Thomas Aquinas: The "Dumb Ox." New York: Doubleday and Company, 1956, 94.)
The Case for Expanded Ownership

The above quotation is particularly apt when the subject under consideration is the binary economics of Louis Kelso and Mortimer Adler. The principles have been around for more than half a century, and were well publicized in Kelso and Adler's best-selling The Capitalist Manifesto (1958) and The New Capitalists (1961). Nevertheless, virtually the whole of the academic establishment, as well as the majority of the political establishment that (if we believe Keynes) slavishly follows the "academic scribblers" and "defunct economists," appear terrified of discussing or debating the merits of Kelso and Adler's work.

Economists high and low, well-known and obscure, capitalist and socialist and everything in between, have studiously avoided coming to terms with binary economics. They claim that they could, of course, refute everything . . . but they don't have the time, they have better things to do, it would be useless to discuss such controversial issues with people who clearly don't understand . . .

The obvious conclusion to draw from such responses is that, having become slaves of the assumption that only existing accumulations of savings can be used to finance new capital formation, the general run of academic economists cannot, despite their assertions to the contrary, actually refute the principles of economic justice or the theory and practice of pure credit financing.

For our purposes we only need to outline the case for expanded ownership very briefly. A much more in-depth treatment of the issue (and probably better written) can be found in The Capitalist Manifesto and The New Capitalists. A detailed examination of the principles of binary economics can be found in Binary Economics: The New Paradigm by Dr. Robert H. A. Ashford and Rodney Shakespeare (Lanham, Maryland: The University Press of America, 1999).

To summarize the case for widespread direct ownership of the means of production, we begin with human dignity and personal sovereignty. This may sound like an unusual place to start when discussing economics. As Adam Smith pointed out in the opening passages of The Wealth of Nations, however, the purpose of production is consumption — and that implies consumption by everyone.

Further, each person's inalienable rights to life, liberty, and the pursuit of happiness necessarily imply the natural right to own an adequate stake of income generating assets: capital. We will not prove that assertion here. Kelso and Adler give an extended and very sound argument in support of this claim in The Capitalist Manifesto, so we will simply follow the lead of George Mason in his draft of the Virginia Declaration of Rights — which provided the model for the Declaration of Independence a month later — and state that it is self evident that each human being has the natural right to own the means of production.

Why direct ownership of capital has become increasingly essential as technology advances should be equally self evident, but we'll summarize the argument briefly. When human labor was the predominant factor of production, everyone naturally had the natural ability to contribute to production. Slavery was an attempt, quite successful, to misuse power to concentrate ownership of the means of production. Political means were the correct way to deal with unjust slavery. ("Just slavery" — if the term doesn't sound completely irrational — technically refers to the permanent or temporary suspension of the exercise of rights in punishment for a crime for which someone has been justly and duly convicted.)

Unfortunately, this gave the illusion that, as successful as the State might be in protecting liberty, it was also the proper agent to see that people enjoyed the fruits of ownership of technology instead of protecting the rights to and of property and ensuring equal opportunity to own. This appeared to justify Keynesian redistribution of profits properly belonging to the owners of capital, instead of the proper corrective of opening up access to the means whereby workers and others without ownership of the means of production could become owners.

The fact is that as technology — capital — becomes responsible for more and more production of marketable goods and services, human labor becomes relatively less valuable as an input to production. This, of course, says nothing about the value of a human being as a human being which, given humanity's inalienable rights, is infinite in human terms. It is an observation based solely on human labor as a physical factor of production.

Principles of strict justice require that, just as the owners of labor receive a just wage for selling their labor, the owners of capital must receive a just profit. The problem is that, when capital replaces human labor as the predominant factor of production, more income flows by right to the owners of capital, and less to the owners of labor, who may thereby sink below the level required to meet common domestic needs adequately.

The solution, as Kelso and Adler saw it, is to democratize access to money and credit so that people who formerly had only their labor to sell can now own the capital that is in the process of replacing their labor. Consequently, any State or other political entity that fails to promote widespread direct ownership of the means of production has failed in its chief duty to protect and maintain the common good. Any financial system — including a currency union — that inhibits or prevents democratic access to money and credit is not filling its proper function as a uniquely social good.

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