Interest-Free Money, Part IX: Reforms

The global economy is a system built to collapse. The stresses caused by the terrorist attacks on 9/11 merely exposed serious problems that had been building up for nearly two centuries. As advancing technology made labor redundant and cheaper labor in other parts of the world became increasingly accessible as a result of improvements in transportation systems, wages alone proved insufficient to provide adequate income.

The Root of the Problem

This would not have been a problem had not the belief in the necessity of existing accumulations of savings — achieved only by cutting consumption — to finance capital formation become accepted as a virtual religious dogma. This ensured that most people would have to rely on wages as their sole source of income at a time when technology was rapidly becoming the predominant factor of production. Only the rich have the ability to save by cutting consumption without suffering deprivation, so — as a general rule — only those who already owned the capital that was generating most production and thus income were and are able to own future capital.

The fact that the utility of existing accumulations of savings in financing new capital formation is problematical at best has made no difference. People (especially those with political and financial power) believed it to be true, and shaped the institutional environment — "the system" — to conform to that belief. As we have seen, however, the idea that new capital formation cannot be financed except by cutting consumption and savings does not conform to reality.

The flaws built into the system have thus resulted in a situation in which, to try and hold things together, those in power have extended their control over both politics and economics. While this has resulted in most people losing a great deal of control over their own lives, it has not brought about the hoped-for results.

In the political realm, the effort to try and keep the system functioning has resulted in increasing amounts of legislation attempting to impose results, rather than reforming the system itself so that it functions properly. Economically, this has resulted in seriously distorting monetary and fiscal policy to try and force the system to work against human nature and common sense.

Manipulation of the Rate of Interest

As one major example, almost exclusively due to the belief that only existing accumulations of savings can be used to finance new capital formation, the money creation powers of the Federal Reserve, the central bank of the United States (intended to be used to provide the private sector with adequate liquidity), have been used to finance government operations. To further this objective, interest rates — the share of profit due to owners of savings — on existing accumulations have been artificially manipulated, and imposed unjustly on pure credit loans when no existing accumulations were involved except as collateral or to provide reserves.

This method of funding government expenditures has deprived the private sector of this source of financing. In addition, misuse of the central bank by the State has resulted in a currency that is almost completely backed with government debt and "toxic" assets purchased to provide politically motivated price supports for failed stock market speculation. To encourage the savings that mainstream economists and the policymakers who rely on them believe are necessary to finance new capital formation, the tax system favors the concentrated ownership on which Keynesian economics relies, and treats property income differently from wage income.

Within the conceptual framework dictated by what Kelso and Adler called "the slavery of [past] savings," the State ends up trying to do everything. The role of the State expands from its legitimate job of policing abuses, enforcing contracts when there is a dispute over the terms, and in general providing a "level playing field" — in short, caring for and maintaining the common good — to attempting to care for each person's individual good.

The common good is not the aggregate of individual goods in society, nor is it goods that, for the sake of expedience, are owned "in common" by the State on behalf of the citizens. The common good is the one good that is common to all humanity: the analogously complete capacity to acquire and develop virtue, "virtue" being construed as "human-ness."

"Man is by nature a political animal." (Aristotle, The Politics, I.ii.) This means that the human person is an apparently unique combination of individual and social. He or she thus carries out the task of developing as a human being within the consciously structured framework of the polis, that is, the political unit. The common good, therefore, manifests itself as the complex network of institutions that make up "the system," and which is intended to assist each human being to develop more fully as a human person.

The State's job is therefore not to provide for each person's individual good, except as an expedient in a time of extreme emergency. Rather the role of the State is to ensure that each person has an equal opportunity to pursue his or her individual goods, assisting in this process by maintaining a justly structured institutional environment within the political unit under its purview.

Functional Overload

When the State goes beyond this legitimate but limited sphere of action, it rapidly approaches a condition of "functional overload." By trying to do everything, the State ultimately ends up doing nothing other than spreading chaos. As a result of the slavery of savings, methods of corporate finance and the tax system concentrate ownership of the means of production. This requires increasing levels of State control to keep the economy running until it takes on too much and implodes. In the meantime, the wealth gap increases, society decays, and extremism is heightened.

A less-than-modest example of the functional overload of the State is the colossal mess of Social Security and Medicare. These programs were "sold" to the American public as an emergency social safety net and, as such, never intended to provide the entire retirement package for everyone.

Prior to the September 11 attacks, according to the Washington Post, congressional estimates projected that the government would drain almost all the Social Security surplus to operate at current levels through 2011, "imperiling the retirements of the baby-boom generation." (Michael Grunwald, "Terror's Damage: Calculating the Devastation," The Washington Post, October 28, 2001, A12.) In the face of massive layoffs and economic displacement caused by the attacks, Congress must now consider in its budget debates the billions needed to cover the replacement of destroyed property, insurance losses, homeland security, rebuilding postwar Iraq and Afghanistan, and the massive cost increases caused by the various stimulus packages and bailouts. In the long-term, then-Federal Reserve Chairman Alan Greenspan warned that the demand for added security will force firms to cut back on employment and productive activities such as research and capital investment. (Ibid.) That this has taken place in the present "Great Recession" is obvious.

The bipartisan Presidential Commission on Social Security issued its final report, Strengthening Social Security and Creating Personal Wealth for All Americans, on December 11, 2001. The report concluded: "Social Security is in need of an overhaul. The system is not sustainable as currently structured. . . . (p.7)" While the commission members agreed on the use of Private Savings Accounts (PSAs) to allow Americans to invest in the stock market a portion of their Social Security funds, they were unable to offer a unified set of recommendations. There was no consensus on what percentage of Social Security assets should be put into publicly traded securities. It was also assumed that there was no better way for workers to invest than to place their wages and savings in the stock market (mainly via mutual funds). Even more important, as many commentators observed, the commission failed to recommend any significant structural reforms for maintaining the long-term viability of Social Security.

Flawed Assumptions

At the inception of the Social Security program in 1936, the United States Government promised explicitly, "What you get from the Government plan will always be more than you have paid in taxes and usually more than you can get for yourself by putting away the same amount of money each week in some other way." (Social Security Board, "Security in Your Old Age" Washington, DC: Government Printing Office, 1935.) Unfortunately and predictably, however, the increase in benefit obligations over time has made the original promise unsupportable, even though today 76% of Americans pay more in payroll taxes than they do in federal income taxes. (Michael Tanner, "Privatizing Social Security: A Big Boost for the Poor," report by the Cato Project on Social Security Privatization, July 26, 1996, SSP No. 4, p.8.)

The basic problem even with the solutions is obvious. Everyone assumes as a given that the only way to finance new capital formation is by cutting consumption, saving, then investing. This automatically shuts out from ownership anyone who does not have enough income to meet current consumption needs, as well as those who, even if not in debt (a very rare condition these days) cannot afford to reduce consumption and suffer a decline in the standard of living. Clearly what is needed is a program by means of which people without savings can invest without cutting consumption.

Capital Homesteading for Every Citizen

The Capital Homestead Act is a comprehensive national economic strategy for empowering every American citizen, including the poorest of the poor, with the means to acquire, control and enjoy the fruits of productive corporate assets. This long-range agenda involves major restructuring of our tax system and our Federal Reserve policies to lift unjust artificial barriers to more equitable distribution of future corporate capital and faster growth rates of private sector investment. It would shift primary national income maintenance policies from inflationary wage and unproductive income redistribution expedients to market-based ownership sharing and dividend incomes.

The Capital Homestead Act's central focus is the democratization of capital (productive) credit. By universalizing citizen access to direct capital ownership through access to interest-free productive credit, it would close the power and opportunity gap between today's haves and have-nots, without taking away property from today's owners.

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 basic interdependent components of the Capital Homestead strategy are like the legs of a three-legged stool:

Democratization of productive credit. Capital Homesteading would reform monetary policy to conform to the goal of sustainable, market-oriented, non-inflationary growth. The new policies would aim at an immediate reduction in prime supply-side credit charges to 3% (without subsidies) for private-sector investment, through a two-tiered credit policy. Central banks would:

(a) Be restrained from further monetization of deficits or encouraging other forms of non-productive uses of credit (i.e., demand-side credit), which would then be forced to seek out already accumulated savings at market interest rates; and

(b) Use the Fed discount mechanism exclusively for discounting, at low discount charges but subject to a 100% reserve requirement, "eligible" industrial, agricultural and commercial paper financed through its member commercial banks. This reform would synchronize the supply of real money with real growth of the economy. It would provide, from the bottom-up, an asset-backed currency reflected in more efficient instruments of production and keep basic economic decisions and corporate accountability in local hands.

Simplification of tax systems. Capital Homesteading reforms would be centered around taxing incomes from all sources (above poverty levels) at a single rate. This would offer a universal yardstick for political hopefuls to compete against, and a direct means for:

(a) Balancing national budgets and restraining overall spending, including social security and Medicare programs;

(b) Ending the use of the tax system to circumvent the appropriations process; and

(c) Eliminating double taxation of profits in ways that maximize greater savings and investments in new plant, equipment, rentable space and infrastructure, plus removing other taxes that discourage expanded capital ownership as a basic pillar of national economic policy.

Linkage between all tax and monetary reforms to the goal of expanded capital ownership. This would encourage every citizen to share directly in the equity growth and profits from our ever-expanding high-technology frontier, and would insure the broadest possible base of private sector stakeholders (and thus political supporters) of reforms affecting "green growth" policies.

In contrast to mounting social security deficits, this strategy would create for every voter a "Capital Homestead Exemption" for accumulating over his or her working lifetime an income-producing, tax-sheltered personal estate of up to $1 million, a modern equivalent of the 160 acres of land that government made accessible to American pioneers.

Citizens would accumulate their Capital Homestead shares in many ways, including such "credit democratization" vehicles as: Employee Stock Ownership Plans (ESOPs); Capital Homestead Accounts (CHAs); Consumer Stock Ownership Plans (CSOPs); and Citizens Land Cooperatives (CLCs). These high-powered financing vehicles would systematically close the wealth and income gap by linking all new monetary and tax incentives for productivity growth under the proposed Capital Homestead strategy, with an ever-expanding base of empowered citizen-shareholders.

Effects of Capital Homesteading

Capital Homesteading will have an immediate effect on the economy. This is because the new capital goods, as Harold Moulton pointed out in The Formation of Capital, are only capital goods to the purchaser — they are consumption goods to the seller. Thus, the immediate effect on the economy in the first year of Capital Homesteading would be a per capita increase in effective demand of approximately $7,000, despite the fact that the Capital Homestead borrower will only get a few dollars, if that, at the end of the year in the first year.

If the government continues to create money backed only by future tax revenues to finance its deficits, we would expect to see moderate-to-high inflation, but the Capital Homesteading program includes cutting off the government from access to the Federal Reserve. What should happen is that the cash that companies have accumulated to finance new capital formation will be distributed as dividends, and treated as tax deductible at the corporate level.

These dividends will, in justice, be paid to the currently wealthy with their virtual monopoly on individual share ownership, and on which they will pay taxes as on regular income. If the rich spend their dividend income, this will generate the consumer demand that drives the demand for capital goods, thereby creating jobs.

If the rich do not spend their dividends, they will have to locate some investment to "park" their surplus . . . yet the capital needs of private sector companies are, presumably, being met completely by Capital Homestead financing. Dividend recipients will either have to find some speculative start-up — or a "safe" investment.

Given that the government will not be able to monetize its deficits, it will be very hungry for funds, and will very likely be the largest borrower of the initial unconsumed dividend payouts that go to the currently wealthy after being taxed as regular income. By draining this "excess effective demand" out of the economy by borrowing and taxing, the government should prevent inflation, even cause a lowering of the price level through a temporary deflation. This will benefit people on fixed incomes, as many of them have invested in government securities as the "safest" investment around. The government will not be able to set the market interest rates any more through its control of the Federal Reserve, and thus retiree income should increase at the same time that the decrease in the price level makes their money go further.

Once private sector companies can discount their paper backed by existing inventories either among themselves ("B2B") or at a commercial bank or even, through legitimate open market operations — as originally intended under the Federal Reserve Act of 1913; it wasn't for government securities — at the Federal Reserve, there will be no question of a permanent deflation, or lack of an adequate money supply. Private companies will simply take advantage of what the Federal Reserve was set up to do in the first place: monetize existing inventories of marketable goods and services through rediscounting and open market operations in privately issued paper, not government bills, thereby providing an "elastic" currency that expands and contracts with the amount of existing marketable goods and services in the economy.

Consistent with Say's Law, private companies that can produce in the near future or have on hand existing supplies of marketable goods and services will, in a sense, create their own money by drawing short-term (90-day) bills (issuing private promissory notes) and either discounting and rediscounting among themselves in high denominations (the lowest denomination of such commercial paper is typically $100,000; $1 million or more is not unusual, there is also a classification for paper denominated in billions now, or, to create money in a form that can be used in day-to-day transactions, discount the paper at a commercial bank in exchange for banknotes (rare, these days) or a demand deposit. Since this type of paper would be based on existing inventories that are already owned and not on future new capital formation that does not yet have an owner, as well as being short-term, the commercial banks should be able to rediscount the paper at the Federal Reserve without the expanded ownership requirement.

Moulton's proposal in the 1930s was not to limit central bank rediscounting and open market operations to monetizing existing inventories, but to finance future new capital formation — financed at the present value of future marketable goods and services to be produced by the new capital — the same way: by rediscounting qualified paper for capital investment for terms of up to five years, not just short-term (90-day) commercial paper backed by existing inventories or the general credit-worthiness of the issuer. Kelso and Adler improved on this by adding that the new capital financed in this way must be broadly owned by people who currently own little or nothing in the way of capital, and adjust the term of the note to make the capital purchase financially feasible.

The bottom line is that, fueled by "interest free money" that does not depend on existing accumulations of savings financing the acquisition of capital by people who currently own nothing, the global economy could conceivably be well on its way to recovery within three months of the passage of the Capital Homestead Act, and make a full recovery within 18 months. Within three to seven years it should be possible to reach the unattainable Keynesian goal of "full employment" — not of labor alone, but of all resources and productive capacity, including labor.

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