Wednesday, July 21, 2010

Interest-Free Money, Part II: Current Views on Money

The principles of Binary Economics admit the use of existing accumulations of savings as possible, but not exclusive in the capital formation process. Louis O. Kelso and Mortimer J. Adler developed the "economics of reality" in response to the discontinuity Kelso observed between production and consumption, the failure of mainstream economics to take into account the dignity of the human person, the natural moral law, and the critical function of private property as a distributive mechanism.

Basic Binary Economics

Kelso and Adler set out the basic principles of binary economics in the two books they co-authored, The Capitalist Manifesto (New York: Random House, 1958), and The New Capitalists (op. cit.). An in-depth treatment of binary economics can be found in Robert Ashford and Rodney Shakespeare, Binary Economics: The New Paradigm (Lanham, Maryland: University Press of America, 1999).

As explained by Kelso and Adler, "binary" means "consisting of two parts." Binary economics divides the factors of production into two all-inclusive categories — the human ("labor"), and the non-human ("capital"). The central tenet of binary economics is that there are two components to productive output and to income: 1) that generated by human labor, and 2) that generated by capital. Classical economic theory, on the other hand, regards all output and income to be derived from labor whose productivity is enhanced by capital.

Naturally, economists who adhere to the mainstream schools of economic thought object to this characterization. They accurately point out that classic economic theory recognizes at least three distinct factors of production, 1) labor, 2) capital, and 3) land. Many economists also add such things as entrepreneurship and money.

Regardless of the multiplicity of factors of production, however, the definition of "productivity" — output per labor hour — effectively ignores anything other than labor as a factor of production. This constitutes tacit acceptance of the labor theory of value: the belief that only labor is ultimately responsible for all production. Consequently, whatever their protests, economists who deny that labor and capital are independently productive, or who insist that "productivity" consists of total output divided by total labor hours, effectively accept the presumption that labor alone generates all marketable goods and services.

The Effect of Technology

As technology advances, it replaces labor in the production process at an accelerating rate. Hunting and gathering is predominantly, sometimes exclusively labor-oriented. Farming at a subsistence level is more capital intensive, especially when we include land in the category of capital, but still predominantly oriented toward labor as the primary factor of production. The capital is independently, but by no means autonomously productive.

As technology takes over more and more of the direct production of marketable goods and services, the direct labor input to production decreases dramatically. From hand-weaving on a loom and providing most of the motive power, the artisan changes into a loom supervisor, someone who minds the loom and only has direct input when setting up or fixing a problem while the loom does most of the work.

When machines start to self-diagnose and correct, the human input is reduced to an occasional push of a button and, finally, to someone who stands around or sits behind a desk in order to "create" a job to redistribute profits by calling them wages, and provide the consumer with effective demand. The worker changes to employee; direct productive work by means of human labor becomes relatively rare. Writing in 1936, Dr. Harold G. Moulton, president of the Brookings Institution, observed,
It is significant to note that since the World War there has been a marked tendency toward contraction in the volume of employment furnished by manufacturing. Despite the increase in population, the number of wage earners in 1929 was lower than in 1919. The decrease cannot be explained by cyclical differences in economic activity between the two years for in 1929 manufacturing production was the highest ever attained and was, in fact, almost 50 per cent higher than in 1919.

An opposite tendency from that observed in the case of wage earners is found for salaried workers. The number of the latter has tended to increase. But even when wage earners, salaried workers, and entrepreneurs are combined, the evidence forces the conclusion that in absolute numbers manufacturing is barely holding its own in furnishing direct employment and, like agriculture, it is becoming relatively less important. (Harold G. Moulton, The Recovery Problem in the United States. Washington, DC: The Brookings Institution, 1936, 153-154.)
A brief note of explanation is required. Moulton did not mean that manufacturing and agriculture were unimportant as sources of marketable goods and services — they are, in fact, essential; a country cannot long survive without being able to feed itself or produce basic manufactured goods. Moulton was making an observation of the importance of agricultural and manufacturing as a source of employment in an economic recovery — the discussion comes in Chapter VI "Employment and Unemployment." It reflects Moulton's concern that production and employment are the two primary areas of focus in any viable recovery program:
Production and employment are basic and ultimate points of reference in modern industrial life. Depression, like prosperity, is a phenomenon which is significant primarily in these terms, and no understanding of the factors of recovery may be gained without a thorough consideration of these two elements of economic activity. (Ibid., 114.)
The issue that Moulton failed to address, however, is, what to do with the people whose labor has been replaced by advancing technology. Kelso and Adler advocated that, with capital replacing labor as the predominant factor of production, workers — and, eventually, everyone — must become an owner of a capital stake with the capacity to generate an adequate and secure income sufficient to meet common domestic needs adequately.

Kelso and Adler were not the first to make this observation. A program of widespread direct ownership of the means of production as the solution to economic and social problems has a long and venerable history. From the Biblical "vine and fig tree," through the attempted reforms of the Gracchi brothers in the late Roman Republic, the 7th century Byzantine "Farmers' Law," even the recommendations of Charles Morrison in the mid-19th century that workers must somehow become shareholders in the corporations that employ them, down to Abraham Lincoln's 1862 Homestead Act and the writings of Judge Peter S. Grosscup in the early 20th century, the importance of widespread direct ownership of capital has been a theme throughout western political history. As William Cobbett, an early 19th century political commentator declared,
Freedom is not an empty sound; it is not an abstract idea; it is not a thing that nobody can feel. It means, — and it means nothing else, — the full and quiet enjoyment of your own property. If you have not this, if this be not well secured to you, you may call yourself what you will, but you are a slave. . . . You may twist the word freedom as long as you please, but at last it comes to quiet enjoyment of your own property, or it comes to nothing. Why do men want any of those things that are called political rights and privileges? Why do they, for instance, want to vote at elections for members of parliament? Oh! because they shall then have an influence over the conduct of those members. And of what use is that? Oh! then they will prevent the members from doing wrong. What wrong? Why, imposing taxes that ought not to be paid. That is all; that is the use, and the only use, of any right or privilege that men in general can have. (William Cobbett, A History of the Protestant Reformation in England and Ireland, § 456.)
Kelso and Adler were, however, to the best of our knowledge the first to bring together widespread ownership of capital and advanced concepts of finance that have the potential to free exercise of the right to be an owner from dependence on existing accumulations of savings. This is the significance of the subtitle of their second collaboration, The New Capitalists: "A Proposal to Free Economic Growth from the Slavery of Savings."

The Binary Definition of Money

Not surprisingly, then, in addition to the areas of disagreement noted above, Binary Economics differs from mainstream economics when it comes to defining money. The standard definition of money is 1) a medium of exchange, 2) a store of value, 3) a standard of value, and 4) a common measure of value. (William Stanley Jevons, "The Functions of Money," Money and the Mechanism of Exchange. New York: D. Appleton and Company, 1898, 13-18.) Frequently, economics texts will elaborate on this definition and add the standard legal definition of money, that used in Binary Economics: anything that can be used in settlement of a debt.

So far, so good. The definitions of money used in most schools of economics and Binary Economics seem to be in substantial agreement. Unfortunately, confusion immediately and inevitably sets in. Economists — and this appears to be completely unconscious, dictated by the general acceptance of the dogmatic belief that only existing accumulations of savings can be used to finance new capital formation — truncate the first two meanings of money, and expand the second two to fill the void.

To prove this point, we picked an economics textbook from the shelves at random. Really — this was the first text this writer came across after less than a minute of searching through the stack of economics texts accumulated from college, graduate school, and continuing professional education. Opening to the definition of money (not presented until page 286), we found the statement, "Money is ordinarily defined as anything that is generally accepted by the public in payment for goods, services, and other valuable assets and in the discharge of debts." (Edward Shapiro, Macroeconomic Analysis, Third Edition. New York: Harcourt Brace Jovanovich, Inc., 1974, 286.) There are a few apparently unnecessary additions to the basic definition here, but they seem unexceptional . . . unexceptional, that is, until we read a little further:
Strictly speaking, only currency, coin, and bank demand deposits qualify under this definition. Time and savings deposits, savings and loan shares, U.S. Savings Bonds, U.S. Treasury bills, and other federal government obligations near maturity come close to being money in this sense, for they may usually be converted into money quickly and with practically no loss of value. However, since these assets cannot generally be used to make payment until converted into coin, currency, or demand deposits, they do not fully qualify as money and are referred to instead as "near-money." If we choose to define money narrowly as anything that is generally acceptable as a means of payment, the total money supply at any point in time equals the sum of currency (which hereafter will be understood to include coin) and demand deposits that are held by the public. (Ibid.)
The problem with this explanation is that it does not reflect reality. Quickly reviewing the definitions, we immediately realize where part of the problem lies. Using the generally accepted definition of money, we gave the first two parts as a medium of exchange and a store of value. We should have said, the medium of exchange, and the store of value.

There's the Rub

By saying that money is a medium of exchange and a store of value, we implied that something other than money could be used as a medium of exchange and a store of value. This, however, contradicts the legal definition of money as anything that can be used in settlement of a debt, and thus "store" value as well as convey a claim on something of value. If, as Binary Economics includes as a basic principle under the natural right of private property, money is the medium of exchange, then, obviously, all exchanges and contracts involve money in some form, not just those exchanges involving currency and demand deposits.

Limiting our definition of money to currency and demand deposits, in fact, involves us in endless contradictions and difficulties, as John Fullarton noted in 1845 in his commentary on the British Bank Charter Act of 1844, On the Regulation of the Currencies of the Bank of England (London: John Murray, 1845). A necessary corollary to the dogmatic belief that new capital can only be financed out of existing accumulations of savings, limiting the definition of money to currency and demand deposits has tied conventional economists and the policymakers who rely on them into knots for decades. The truncated definition of money has distorted fiscal and monetary policy to the detriment of sound economic growth and monetary stability.

A brief look into The New Palgrave: Money, for example (John Eatwell, Murray Milgate, and Peter Newman, editors, The New Palgrave: Money. New York: The Macmillan Press, Ltd., 1989), reveals that the authors of many of the articles spend a great of space wrestling with the difficulties caused by restricting the definition of money to this extremely limited understanding. Dr. Milton Friedman's article, for example, is primarily concerned with adding a large number of additional variables to Irving Fisher's simple quantity theory of money equation, M x V = P x Q. This is necessary in order to try and make the equation work after unconsciously changing the meaning of "M" — the quantity of money — by limiting it to currency and demand deposits.

The Real Money Supply

Is, however, money limited to currency, demand deposits, and selected time deposits? Evidence in the form of empirical data suggests otherwise, as does common sense. The vast majority of transactions in the world involve something other than currency and demand deposits, although, admittedly, the proportion of non-currency and non-demand deposit transactions has decreased dramatically concurrently with the intrusion of the State into the economy.

The fact is that most exchanges in the world are still carried out using something other than currency or demand deposits. International trade, for example, usually involves either direct exchange of commodities or finished goods ("barter") or bills of exchange, that is, privately issued money — promissory notes — drawn on the present value of existing or future marketable goods and services, usually (though not necessarily) denominated or measured in terms of the official currency.

Often this done without the intermediation of a bank, between two parties who trust each other and have no need of third party verification or any other involvement. A problem arises only when one or both of the parties fail to keep the agreement according to the terms of the contract. This flatly contradicts the assertions made by, e.g., John Maynard Keynes in his collectivist A Treatise on Money (1930). As Lord Keynes asserted — completely without a shred of proof, it should be noted,
It is a peculiar characteristic of money contracts that it is the State or Community not only which enforces delivery, but also which decides what it is that must be delivered as a lawful or customary discharge of a contract which has been concluded in terms of the money-of-account. The State, therefore, comes in first of all as the authority of law which enforces the payment of the thing which corresponds to the name or description in the contract. But it comes in doubly when, in addition, it claims the right to determine and declare what thing corresponds to the name, and to vary its declaration from time to time — when, that is to say, it claims the right to re-edit the dictionary. This right is claimed by all modern States and has been so claimed for some four thousand years at least. It is when this stage in the evolution of Money has been reached that Knapp's Chartalism — the doctrine that money is peculiarly a creation of the State — is fully realized. (John Maynard Keynes, A Treatise on Money, Volume I: The Pure Theory of Money. New York: Harcourt, Brace and Company, 1930, 4.)
"Knapp's Chartalism," we should explain, is the theory that money properly consists only of government-issued or created tokens, currency, and demand deposits. (Vide Georg Friedrich Knapp, The State Theory of Money. London: Macmillan and Co., Ltd., 1924.) In a chartalist system, the government prints fiat currency or creates demand deposits as the whole of the money supply. Private transactions between individuals coming together in free association are forbidden (c.f. Thomas Hobbes, Leviathan, II.22). The State spends the money into circulation to cover its deficits, and then taxes income to reclaim any excess and control the total amount of fiat money in circulation. "Reclaiming" money via taxation (which term — "reclaiming" — implies State ownership of everything in the economy, to say nothing of absolute control) is essential to maintaining the value of the currency.

Chartalism is the logical development of something called the "British Currency School." The Currency School limits the definition of money to coin, banknotes and (although rejected by some purists) demand deposits. Nothing other than that which is specifically authorized by the State constitutes money. Banknotes must either be backed by gold or silver (specie), or by the State's promise to redeem the banknotes out of future tax revenues (anticipation notes). Interpreted strictly — as do the Keynesians and, under certain circumstances, the Monetarists and Austrians — all money is under the direct control of the State, and can consist only of notes backed by State debt. (Perhaps it would be more accurate to say that the Monetarists and Austrians acquiesce in this, but, to varying degrees, do not accept its legitimacy.)

This misunderstanding of money has become so egregious that the Federal Reserve recently removed "M3" — M2 (coin, currency, demand deposits — M1 — plus savings, small time deposits, overnight "repos" at commercial banks, and non-institutional money market accounts) plus deposits at institutions that are not banks, such as savings and loans — from its definition of the money stock. Henceforth Federal Reserve authorities (and thus the policymakers who rely on their understanding of money and credit to set federal government monetary and fiscal policy) ignore the possibility that anything other than M2 is money.

The problem, of course, is that even M3, defined by most economists as the measure of the total money supply, was inadequate. A minor point is that "savings and loans" and similar institutions such as credit unions are banks — banks of deposit. The major problem, however, is that (consistent with the dogmas of the Currency School) even M3 completely ignored more than half the money supply: private sector financial instruments used to carry out transactions, i.e., "settle debts," and thus serving as a medium of exchange to convey property rights.

The Errors of the Currency School

The falsity of the premises of the Currency School is easily demonstrated. A crude calculation can give us an idea of the degree by which the real money supply exceeds the limited notion currently in use by virtually all economists. In 2008, GDP was $14.3 trillion (IMF data). To GDP we add imports of $2.523 trillion (U.S. Census Bureau/U.S. Bureau of Economic Analysis, "Exhibit 1: U.S. International Trade in Goods and Services, Jan-Dec 2008," News, U.S. International Trade in Goods and Services, Annual Revision for 2008, 1). The velocity of money is c. 4.1. (Frederic S. Mishkin, The Economics of Money, Banking, and Financial Markets. London: Addison-Wesley, 2004, 520.) Finally, according to the Federal Reserve, M2 was approximately $1.624 trillion in 2008. Using M x V = P x Q, M x V gives us $6.66 trillion. We subtract $6.66 trillion plus total exports from GDP of $16.823 trillion, leaving $10.163 trillion in transactions that cannot be accounted for, or more than 60% of the money supply.

Sixty percent seems awfully large until we learn that, in 1839, Congressman George Tucker estimated such "private sector money" (if we may so term it) as being in excess of 90%. (George Tucker, The Theory of Money and Banks Investigated. Boston, Massachusetts: Charles C. Little and James Brown, 1839, 130-144.) Of course, we have to realize that the role of the State in Jacksonian America was much more limited than today, especially in the economy. The attempt by the federal government to control the money supply by shutting down the Second Bank of the United States and promulgating the Specie Circular in 1836 was a total disaster. It caused a nationwide depression — "Hard Times" — that had serious repercussions in Europe.

Are, however, the assertions of conventional economists as to the makeup of the money supply and the power of the State to control that supply absolutely, in fact true? Is the State the only entity that has the power to define and create money? Must all money necessarily be based on existing accumulations of savings?

Or is there another possible arrangement of the economic and financial system — something more in tune with reality and the way things really work. That is the issue we will address in the next posting.


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