The Keynesian Bloodletting

As predicted over and over on this blog, the remedies being applied to virtually every area affected by the economic crisis are not curing anything. Quite the contrary — what's being done is aggravating the situation even more than previously. It's analogous to the state of medicine in the 18th century, in which Hippocrates's theory of the "four humors" that must be kept in balance, i.e., black bile or "melankholia," yellow bile or "cholera," phlegm or "phlegma," and blood or "sanguis." These were believed to have an effect not only on the physical body, but the mind as well, hence some of our modern terms for a person's temperament: melancholy, choleric, phlegmatic, and sanguine.

These four humors, black bile, yellow bile, phlegm, and blood, corresponded to the four elements of Greek physics, earth, fire, water, and air, respectively. The theory was that when the humors are out of balance, they must be put back in balance by increasing the one that was diminished, or taking out some of any excess. Hence, a physician's stock in trade consisted of drugs and techniques either to get the excess or poisoned humors flowing out of the body, or induce the body to produce more of a healthy humor.

There is actually a good deal of common sense in the theory. Many diseases respond to treatment of a symptom. Cholera, for instance, is not a fatal disease — but the symptoms, chronic diarrhea and vomiting as the body struggles to eject the harmful organism, will dehydrate the body and cause death; in a sense, the body kills itself. There is a cholera vaccine that is mildly effective in preventing the disease, but the prescribed treatment is usually oral or intravenous rehydration — i.e., replace fluid as fast as possible, and keep doing it.

Unfortunately, over the centuries the theory got a little over-simplified. While bloodletting can be an effective treatment in some (very rare) cases, it became virtually the only one used for every imaginable ailment. Of course, there were sometimes complaints about the ineffectiveness of other humor-balancing therapies, such as when incompetent physicians prescribed drugs that made you sick, and emetics that didn't, but, by and large, the most popular treatment was to whip out the knives and drain a little (or a lot) of blood out of the patient, or attach leeches and let them do the dirty work.

Now we get to the point of all this fascinating medical history. In Keynesian economics, the way out of a depression or recession is for the State to create money backed by future tax revenues (not that a Keynesian, Monetarist, or Austrian would put it that way), stimulating demand, and creating jobs.

In the Keynesian reality the amount of debt assumed by the State doesn't matter. All the State does in the Magic Kingdom of Keynesland is redistribute purchasing power, not create new purchasing power by tying new money to the present value of existing and future marketable goods and services.

Unfortunately, the financial system doesn't operate in the Magic Kingdom, but in the real world. Debts must be paid — and paid when due. The State cannot continue to redistribute existing wealth forever and put off the day of reckoning on to future generations; the bloodletting can't go on without a transfusion in the form of new production of marketable goods and services. The alternative is economic death.

The politicians and policymakers seem to realize this at some basic level. As an article in today's Wall Street Journal makes clear, the situation in Éire, Spain, and Portugal is getting out of hand; the fixes a short time ago didn't fix anything. All they did was make the situation worse. ("European Austerity Fuels Tensions," WSJ, 09/30/10, A8.) What is needed is cost cutting and austerity to get things back on course.

Cost-cutting, however, should — at least in a well-managed company or country — be a last resort, not the first. No company or government should ever be spending money it doesn't have to spend, certainly not in an insane effort to foster prosperity by going into non-productive debt. The first recourse of any company or government in trouble is not to cut costs, but to increase revenue, that is, grow economically.

The problem is that, within the Keynesian system, manipulation of monetary and fiscal policy (i.e., going into debt in different ways and taxing a depleted tax base) is the only source of financing for the growth that generates the tax base that provides the money for government to spend. In simple terms, in Keynesian economics you don't dare stop spending, even if you could. If you don't have government debt, you don't have a money supply. But it's debt that's causing the problem. Like the loss of fluid that characterizes cholera, the Keynesian defense mechanism is killing the body politic it is supposed to be preserving.

What's obvious, of course, is that the Keynesian prescription must be wrong — as is the whole Keynesian theory of how the body politic works. No organism, biological, social, or political, can live on itself forever without producing anything, nor can any organism survive in its own waste products. The State cannot redistribute existing wealth forever, anymore than an animal can live off its stored fat without eventually feeding; the State cannot survive being drowned in its own debt, anymore than animals can breathe the carbon dioxide they exhale.

The Just Third Way would solve this problem. First, we need to redefine money and credit so that they bear some resemblance to reality. Forget "M1" and "M2." Money is anything, repeat, anything that can be used in settlement of a debt. Next, restore Say's Law of Markets and the real bills doctrine by reforming the financial system and tying all new money to the present value of existing and future marketable goods and services. At the same time, institute an aggressive program of expanded capital ownership, and reform the tax system.

All of these steps are explained in Moulton's The Formation of Capital and CESJ's Capital Homesteading for Every Citizen. Consider obtaining copies today — and opening the door to a prime mover who has the political savvy to listen to and understand the Just Third Way.

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Both Ends Against the Middle

You can say what you like about President Obama and his efforts to disengage the United States from Afghanistan, but he is at least consistent — consistent in missing the point and not seeing the obvious. In today's Washington Post, it is becoming increasingly evident that Mr. Obama hasn't fully grasped the situation in that part of the world . . . or in this part, for that matter. ("Obama's Wars: The Pakistan Conundrum," The Washington Post, 09/29/10, A1, A13.) He seems to keep insisting that programs and policies based on flawed principles — where there are principles at all — are going to work. We just need to make a greater effort, reach out to more people . . . and spend more money. Unfortunately, proceeding on the basis of flawed principles is indistinguishable from denying reality.

The reality of the situation in Afghanistan is that the war is being fought by elements that can retreat across the border into Pakistan any time Afghanistan gets too hot for them. This is a standard technique in "low intensity conflict," or the sort of war you fight without "set battles" where the two sides line up and slug it out (that's more than a little oversimplified, but we're trying to make a point here). It's like the bully who can run into his house after beating you up when he sees your older brother coming, and then sneer at you from the safety of his (parents') living room. If you take the bait and throw a rock through the picture window, it will not be the bully who suffers, but the bully's parents, your parents . . . and, especially, you, for being so stupid.

Of course, the right thing to do would be to go to your parents and get them to try and get the bully's parents to put a stop to his anti-social activities. (Don't laugh. It could happen.) Failing that, get the police to take action . . . if you don't mind being completely ostracized by the neighborhood for being such a baby and calling in the cops when you should be handling it yourself. (Which begs the question — if you could handle it yourself, why would you call in the cops?) The problem in Afghanistan is that the bully's "parents" — the civil and military authorities giving the bully safe refuge — are either unable or unwilling to do anything about the problem . . . and the "police" (the United States) are themselves the ones being bullied.

Of course, even if the Pakistani authorities could be persuaded to act — and Mr. Obama is working on the ineffectual civil administration rather than the military that would be able to act effectively — there is no long term (or short term) program to deliver justice, both economic and political, the lack of which is at the root of the situation. For its part, of course, the military prefers to blame India for all its problems, thereby avoiding being attacked by the bully themselves.  Only a program that would build ownership into all citizens, including (or especially) the military — such as Capital Homesteading — has any chance at succeeding, if only by giving the military a stake in establishing and maintaining a peaceful and just society.

Capital Homesteading deserves consideration not just because it would bring justice to all Americans, but because it has the potential to extend the real American revolution throughout the globe, establishing peace and justice everywhere.

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The New Manifest Destiny

Once again we've managed to fall behind on the writing for the series on Say's Law of Markets and the real bills doctrine. Our excuse this time is that the next scheduled posting in the series is on the Panic of 1893 and the ensuing Great Depression — yes, Virginia, there was a Great Depression before the 1930s, much greater in scope than that which ran from 1930 to 1938. While there were calls to inflate the currency and devalue the dollar in the 1890s, as well as for massive job creation, the federal government did none of these things. In consequence, the (first) Great Depression dragged on from 1893 to 1897, while that of the 1930s was over as soon as the Second World War was able to put the economy back on its feet. If they had had experts willing to end either the first or second Great Depression sooner by announcing that fact, of course, they would have enjoyed benefits commensurate to what we have today.

In any event, we'll get to that when we get to it. (We're pushing hard on an unrelated project to get it out before Christmas, and it's taking a bit of time away from this blog and other non-profit matters.) What we'd like to look at briefly today is a recent article that appeared on Yahoo! News: "10 Signs The U.S. Is Losing Its Influence In The Western Hemisphere." We won't bother going down this rather grim "Top Ten"; even Letterman's turgid humor is more amusing. You can read the article for yourself, but evidently the new destiny that is manifest for the United States is to sink permanently into the status of third rate power, going hat-in-hand to the new top dogs in the world.

What you should keep in mind as you read it, however, is that there is not one single "sign" that the United States is "losing its influence" that Capital Homesteading would not only reverse, but put the United States permanently in the "Number One" spot for "influence." How? By exporting justice instead of competing in an artificial "lose-lose" global economy in which it is impossible for anyone to "win." The "comers" among the economies listed in the article are not really moving into the number one spot(s) by anything other than default, for the advantages they currently have are just as ephemeral as those presumably enjoyed by the U.S. after the land frontier closed down in the 1890s (vide the Great Depression of 1893-1897, above).

So, what is to be done? To replace the limited land frontier, we need to open up the industrial and commercial frontier. That's fine, you say, but how are we supposed to finance the acquisition of capital by people who don't have existing accumulations of savings, and who can't afford to cut consumption to start saving?

If you have to ask, you haven't been paying attention to the last three years of postings on this blog. As Dr. Harold Moulton explained in 1935 in The Formation of Capital — written to propose a financing strategy to get America out of the second Great Depression — new capital formation can be financed without recourse to existing accumulations of savings. By expanding commercial bank credit to finance new capital formation and releasing existing accumulations of savings to finance consumption, an economy can experience explosive rates of growth without being tied to the Keynesian "production possibilities curve" that takes the limits of growth imposed by past savings as a given.


Tie in Louis Kelso and Mortimer Adler's insights about the necessity of widespread direct ownership of the means of production, financed with "pure credit" as described by Moulton and collateralized with capital credit insurance and reinsurance, and you have a solid and sound proposal for putting America back on top — and keeping it there.  Further, it doesn't have to be exclusive to the United States.  Why shouldn't everybody in the world come along for the ride?

Why should America settle for being anything other than "Number One" — especially when we can make everyone else Number Ones as well?

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Say's What?

Over the weekend a faithful reader made the comment that the current series on Say's Law of Markets contradicts monetary reform researchers on such concepts as the Bank of England being government controlled in its early days. The reader thought the evidence points to the idea that the monetary reform researchers are correct, presumably in that the Bank of England was allegedly not controlled by the government, but by a small group of people intent upon controlling money and credit to their advantage. Well . . . it’s something of a diversion from pushing our new books, e.g., Supporting Life, but we’ll give answering a shot.

First, we would want to see specific names of the monetary reform researchers, especially since all the evidence we have surfaced from our sources — referenced in the blog postings (e.g., Adam Smith, Henry Thornton, Jean-Baptiste Say, Richard Hildreth, George Tucker, John Fullarton, Charles Conant, Harold Moulton, and Kelso and Adler) — are quite explicit. We have a hunch that the monetary reform researchers may be confusing nominal title and actual control.

Also, the reform researchers with whom we are familiar, from Fahey, Coogan, Coughlin, et al., mis-define money and credit. They take the disproved Currency School of finance as normative, dismissing or rejecting Say's Law and the real bills doctrine — the heart of Binary Economics and the Banking School — as a fraud or theft on the basis of that mis-definition. They are, in essence, speaking a different language than is used in Binary Economics, and their observations do not fit within the new paradigm.

The fact is that anyone may hold nominal legal title, e.g., the member banks of the Federal Reserve System who own non-voting, non-participating, non-transferable "shares" in the Federal Reserve. The issue is who really controls. As Moulton made clear in his work on the Federal Reserve in particular and central banking in general, it is who controls and sets the banks' policies who really "owns" in the sense of control. As Moulton pointed out, the federal government appoints the head of the Federal Reserve and can remove him or her at will. The federal government is thus the real owner of the Federal Reserve. From 1694 on, the English government set the rules and dictated in what way the Bank of England could exercise its discounting and note-issuing powers, and in what amount. The English government was thus the real owner of the Bank of England, whatever the shares of stock said.

All of that, however, sidesteps the real issue, which is what are we going to do about it? Whether or not private interests own the world's central banks, or private interests have nominal title while the State holds real title, or the State simply takes over everything and issues the money it needs as in Georg Knapp's "chartalism," which destroys private property through manipulation of the currency as Keynes advocated in the opening pages of his 1930 Treatise on Money — all of this is irrelevant when looking at the main issue, which is how to we correct the flaws in the present system, regardless how they got that way? We could spend all of our time persecuting those whom we believe guilty of structuring the system the way it is, but that would divert attention away from promoting the specific reforms we believe are necessary to correct the system.

The purpose of the present blog series on Say's Law of Markets and the real bills doctrine is not to expose the guilty, punish the evildoers, or proclaim the virtue of glorious failure in the cause of justice. Rather, it is, 1) explain Say's Law and the real bills doctrine not as today's economists have distorted them, but as they really are, 2) in the interests of developing arguments to promote the Just Third Way describe how, given the way the financial system currently operates, it departed from reliance on Say's Law and the real bills doctrine, and 3) (where we're going with this thing) explain the operation of the reformed financial and banking system of the Just Third Way.

To do this requires that we use standard recognized sources and authorities, and the correct definitions of terms and concepts. Exposing the guilty, inventing new definitions, or asserting historical theories that academic economists and policymakers will reject out of hand, true or not, is not our method. As Chesterton pointed out in The Dumb Ox, you can always prove somebody wrong on your principles. The only real way to convince anybody, however, is to prove him wrong on his principles.

Referencing the work of monetary reform researchers whose efforts and conclusions, true or not (and some of us believe they are not true, but that, as we keep saying, is irrelevant), are rejected by the very people we are trying to persuade is a pointless and useless waste of effort. We would spend all of our time — what little we can get with these people — trying to prove something that makes no difference whatsoever, and lose whatever opportunity we have to persuade them to support the Just Third Way. We have to focus on correcting the system, not in identifying and punishing the presumably guilty.

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News from the Network, Vol. 3, No. 38

We only have a little news this week, but it is significant. Given yet one more premature announcement that the recession (depression) is over, it is important not to give in to the pressures exerted to "go along to get along." Also, as the realization begins to hit that nothing has changed and, in fact, is getting worse — despite (or maybe because of) the performance of the stock market (now on a rapid growth streak despite the performance of the economy and the unemployment rate) — it's important that we keep working to get the word on the Just Third Way to door openers and prime movers.

• We were deeply saddened this week to learn of the death of Dr. Raphael Waters on August 26, 2010, founder of the Aquinas School of Philosophy in Buffalo, New York and long time friend and supporter of CESJ. Dr. Waters, an expert in the natural moral law that provides the foundation of Catholic social teaching and the Just Third Way, did his doctoral thesis on participation in God's Knowledge, i.e., the Intellect instead of the Will as the basis of the natural moral law. He will be greatly missed.

• On Wednesday, Norman Kurland attended a symposium at the Cato Institute in Washington, DC, on John Maynard Keynes and Friedrich von Hayek. Taking with him copies of CESJ's new edition of Harold Moulton's The Formation of Capital, Norm was able to ask the first question when the floor was opened up. Norm got copies of The Formation of Capital to Dr. Paul Boettke, a professor at George Mason University, and Fernando Menéndez of the Atlas Foundation, who commented that "it would be good for South America."

• Lic. José Recinos is close to being offered a contract to advise the new Minister of Finance in Guatemala on monetary and fiscal policy from the perspective of the Just Third Way. Joe plans on getting copies of The Formation of Capital as well as an outline of the Capital Homestead Act to the minister at the first opportunity.

• As of this morning, we have had visitors from 40 different countries and 40 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 Bangladesh, the United States, Italy, New Zealand, and Ireland spent the most average time on the blog. The most popular posting is the one on "The New Banking Rules," followed by "The Case for the 'Repeal Amendment'," "Who Shall Decide When Doctors Disagree?" "CESJ's Orientation in Brief," and, finally, the "Common Currency" posting on the Holy Roman Empire.

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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Say's Law of Markets, Part XIII: "The Crime of '73"

Ironically, in the same year as the publication of Lombard Street, the United States passed the Coinage Act of 1873. Twenty years later, when the "Panic of 1893" and the following Great Depression exposed the weaknesses in both the American financial system and the understanding of money and credit prevalent in all quarters of the country, the Act achieved a mythical status all out of proportion to its actual effect and importance. In a frenzy of misdirected populist feeling, the Coinage Act was labeled "The Crime of '73," evidently having managed to hide its true nature for almost a generation.

Formation of a Myth

The Act was not the sinister conspiracy that populist legend has built into a financial bogeyman. It was an attempt to repair the damage done to the credit of the United States by the policies of Salmon P. Chase, who was by this time Chief Justice of the United States Supreme Court, although he had only a short time left to live. Chase's actions, as we have seen, had a devastating effect on the purchasing power and financial position of ordinary wage workers. The real problem was that the presumed remedy ignored the true nature of money found in Say's Law of Markets and the real bills doctrine. Both the framers of the Act and its critics were locked, seemingly irrevocably, into the tenets of the Currency School.

By 1896 and the presidential campaign of William Jennings Bryan, the Coinage Act of 1873 had become enshrined in populist dogma as the key event in an international conspiracy intended to force the nations of the world onto a monetary standard of scarce gold instead of plentiful silver. (Walter T. K. Nugent, The Money Question During Reconstruction. New York: W. W. Norton and Company, Inc., 1967, 16.) It was, in the words of Mrs. Sarah E. V. Emery, one of the "seven conspiracies that shook the world" (Sarah E. V. Emery, Seven Financial Conspiracies Which Have Enslaved the American People. Lansing, Michigan: Robert Smith and Co., 1894.) — all coincidentally perpetrated by Congress during the Civil War and Reconstruction. (Nugent, op. cit., 20.)

The "Crime of '73" thereby made harmful deflation instead of beneficial inflation of the currency global policy. The perfidy was made complete by the fact that the predominant currency wasn't even gold, but (in a fiendishly clever move by the National Banks that refused to lend farmers and small businessmen the banknotes without collateral and unless they paid interest) greenbacks ostensibly backed by gold. Thus, the banks benefited twice: 1) by drawing interest on the government bonds that backed the National Bank Notes, and 2) then drawing interest again on the banknotes themselves when paid out to the public in the form of loans. (Ibid., 17)

Take special note of the accusation that the National Banks were making double profits off of the currency, for it was to dominate discussion of money, credit, and banking for the next twenty years. This obscured the serious problems involved with having a fixed currency of gold, silver, and banknotes, instead of a money supply composed of all forms of money (e.g., demand deposits, commercial paper, drafts, letters of credit, and so on) that could expand and contract to meet the needs of industry, commerce, and agriculture.

The Case for Inflation

Although it dominated politics from 1893 to 1913, the accusation that the National Banks were making double profits on the currency was false. This is because the vast amount of loans for industrial, commercial, and agricultural purposes were not made in the form of National Bank Notes, but as demand deposits — checking accounts — that were not backed by government bonds, interest-bearing or otherwise. The commercial loans were backed by liens on the capital assets financed with the proceeds of the loans, and insured by the collateral pledged by the borrower. (Moulton, The Formation of Capital, op. cit., 104.)

Nevertheless, the claim that banks — especially central banks — are stealing from the public by charging interest on the currency persists down to the present day. This accusation is usually made in extremely distorted, even garbled fashion, having become a serious bone of contention as a result of the Panic of 1907 and the Great Depression, and has now achieved the status of unquestioned dogma. The rest of the catalogue of alleged crimes by the government and the banks also echo down to the present day:

• In March 1869 the government had promised to pay off the Civil War debt in coin rather than in greenbacks.

• In July 1870 the government had passed a law changing the national debt into an obligation of the taxpayers, payable in coin.

• At the same time, a law was passed limiting the circulation of greenbacks.

• In February 1873 the government secretly demonetized silver — the "Crime of '73." (One source ludicrously claimed that the government stopped minting silver. Fred A. Shannon, The Farmer's Last Frontier: Agriculture, 1860-1897. New York: Harper & Row, Publishers, 1945, 315.)

• In 1875 Congress passed the Specie Resumption Act, which deflated the currency until it passed at par with gold. (Nugent, op. cit., 16-17.)

The problem, as the populists saw it, was that the country had gotten heavily into debt to finance the Civil War, using the inflated greenback currency. After the war, there was an international conspiracy to steal purchasing power away from working men and women who were, by and large, in debt due to the rapid loss of consumer purchasing power experienced as a result of the inflation. This was being accomplished by deflating the currency until it could be restored to its prewar value and pass at par with gold. The stated reason for the deflation was to restore the credit of the United States with foreign governments. This would force the country into the power of the Jews, who formed a cabal of international bankers who controlled money, credit, and banking throughout Europe and its colonial empires, and wished to bring the United States under their control.

The ordinary citizen-taxpayers were thereby burdened with paying off inflated debts with deflated, more expensive dollars. This put them into permanent servitude to the banks, especially the National Banks responsible for charging double interest on the national debt. The populist solution was to reinstitute "free coinage" of silver, that is, the policy that all silver brought to the mint would be coined into silver dollars on demand. Because silver was cheap and plentiful, this would cheapen (inflate) the money again, raise prices and wages, and create jobs.

The Case for Deflation

Of course, the argument was not entirely one-sided. For their part, those who opposed the populist position (for whom, unless we want to descend to name-calling, we don't have a label) were convinced that the continued existence of the United States government required restoration of the nation's credit. Their rallying cry was "honest money." (Ibid., 18) In strict conformity with the dictates of the British Currency School, embodied in Sir Robert Peel's Bank Charter Act of 1844 and the United States National Bank Act of 1863 (amended 1864), the only way to do this was to control inflation.

The most basic tenet of the British Currency School was that paper money, regardless how issued, automatically causes inflation. The only question was how much paper to issue in order to keep inflation within tolerable limits, or how to manipulate inflation to obtain desired results. The only way to control inflation was not (in accordance with the quantity theory of money) to increase production, but to take paper currency out of circulation to the maximum degree possible. This required strict State regulation of the amount of currency in circulation, which, in turn, meant that the State had to be able to create or destroy money at will by backing banknotes with government debt. In this system, only gold, gold-backed banknotes, and banknotes backed by government debt constituted "real" money.

To reduce or even eliminate inflation and put the United States back on a sound financial footing, the non-gold currency in circulation therefore had to be replaced with gold and gold-backed banknotes that could be converted to gold on demand. As George S. Boutwell, Secretary of the Treasury in 1873, recalled in his memoirs,

In 1873 I had come to believe that it was wise for every nation to recognize, establish, and maintain the gold standard. I was of the opinion then, as I am of the opinion now, that nations cannot escape from the gold standard in all interstate transactions. . . . The choice of gold as the standard was not due to hostility to silver or to the silver mining interests, but to the well grounded opinion that gold was a universal currency, while in some countries, as in England or Germany, silver coins were not a debt-paying currency. . . . The measure was in accord with my policy, and it was in accord with the unbiased judgment of the commissions. (George S. Boutwell, Reminiscences of Sixty Years in Public Affairs. New York: McClure, Phillips & Co., 1902, II:151-152, quoted in Nugent, op. cit., 19.)

A Non-Conspiracy

The presumed conspirators against silver completely rejected the accusation that they had carried out their program in secret. Congressman (later Senator) John Sherman of Ohio (1823-1900) — the "Ohio Icicle," principal author of the Sherman Anti-Trust Act — had his vehement denial read into the Congressional Record in 1893, when the effective demonetization of silver had been resurrected as a critical issue, twenty years after the event. As Sherman declared, "In every stage of the bill and every printing, the dollar of 412-1/2 grains [of silver] was prohibited, and the single gold standard recognized, proclaimed, and understood. It was not until silver was a cheaper dollar that anyone demanded it, and then it was to take advantage of a creditor." (Congressional Record, XXV (August 30, 1893), 106, quoted in Nugent, op. cit., 18.) As one authority summed up the conflict,

Neither side was totally out of touch with reality. The country had to have credit, and in an age when a very substantial portion of the public bonds had to be sold on foreign markets, the intangible reality called investor confidence had to be guarded integrally, for it was crucial. On the other side, people did not join the Farmers' Alliance and the Populist party or vote for Bryan and free silver in 1896 because they were muckers [obsolete slang term for a slum-dweller or low-born laborer] or out for a cheap buck; nearly two-thirds of the American population was rural in 1890, and economic stringency among farmers was maddeningly real. The leading spokesmen on each side, moreover, repudiated the more extreme accusations that some of their own allies made. Though the Eastern press denounced free silver (as it had denounced greenbackism years before) as anarchy, communism, a criminal conspiracy hell-bent on destroying the Republic, Senator Sherman and other responsible leaders distinguished carefully between free-silver doctrine and the people who accepted it: hate the sin, but love the sinner. (Nugent, op. cit., 20.)

Both sides clearly believed they were right. In a sense, they were — to the extent that each took a similar view of money: "money" and "currency" were equivalent terms. The struggle was over whether an inflated or deflated currency would best serve the needs of the country. Thus, while each side was convinced that the other was wrong about the nature of money, what they differed on was monetary policy. Both sides seemed unaware of the fact that "money" does not consist solely, or even primarily of banknotes and coin, but of anything that can be used to settle a debt.

The apparent collision between the British Currency School and populist politics that shook the United States to the core twice in the late 19th century (Ibid., 21) was thus based on a fundamental misconception. The most astonishing part of the whole affair is that both sides agreed on what they believed to be the real issue — and both were 100% wrong: that it is possible to have a sound or even viable economy when the critical link between money and production is broken. The entire fight was over which interpretation of that misconception would benefit the country most.

Growing Concentration of Ownership

Adding to the fight, although largely unnoticed at the time, was the growing concentration of ownership of the means of production. The Homestead Act had slowed this movement slightly, but only in land — and the murder of "nesters," as homesteaders were pejoratively termed by the large ranchers, was not uncommon when a homesteader filed on land to which a large landowner believed he or she had a better claim, controlled the local law, or had more guns.

The increasingly important industrial and commercial sectors of the economy were left untouched. It was the age of the "Robber Barons." These industrial and commercial magnates used their growing wealth and power seemingly exclusively to gain increasing amounts of yet more wealth and power — and that meant that monopolies and trusts were rapidly becoming the order of the day. In a seeming affirmation of the theories of Walter Bagehot, the economic oligarchy that really ruled England (not to be confused with "The Upper Ten Thousand" that ruled society — briefly and unsuccessfully in the U.S. limited to "The Four Hundred" centered in New York City) completely controlled money and credit.

Exclusivity and elitism were the order of the day, an economic and social Darwinism that devastated American life. With the closing of the land frontier, conditions in the ever-expanding industrial frontier became increasingly intolerable. The fact that many factory workers were former soldiers who had lived through the bloodiest war in American history made recourse to violence a seemingly viable alternative. They had fought to free the black slaves, and saw no reason why wage slaves should continue to be subjected to inhuman conditions in the factories.

The Socialization of America and Europe

Consequently, after a somewhat slow start, socialism was starting to gain ground rapidly. The Socialist Labor Party was founded in 1876 in Newark, New Jersey. Party membership was largely new German immigrants, who imported Marxist ideals. While the party platform was initially a grab-bag of all the different varieties of socialism, by 1890 Marxism established its ascendancy, and the party reconstituted as a Marxist party. The philosophy became somewhat more coherent, and their influence expanded rapidly. By 1900 the Socialist Labor Party was the leading socialist organization in the United States.

The predominant socialist ideology in the United States was what has become called "democratic socialism." The desired goal was to give workers control of the means of production by transferring ownership of capital from capitalists, to those who presumably created all the wealth. This, of course, fits in perfectly with Karl Marx's definition of socialism as "the abolition of private property." (Karl Marx and Friedrich Engels, The Communist Manifesto, 1848.) This is because "property" and ownership consist of the right of control and the right to receive the "fruits of ownership," that is, the income generated by what is owned. Despite the peaceful claims of modern socialists, the movement was involved in riots and strikes, notably the infamous Haymarket Riot of May 4, 1886 in Haymarket Square in Chicago, and the Pullman Strike in Pullman, Illinois, in 1894.

If both socialism and the problems it attempted to address were bad in the United States, matters were much worse in Europe. Socialism in Europe was closely associated with anarchism and atheism. Most especially, of course, socialism was a direct attack on the institution of private property, the foundation of a stable social order. The real problem that the socialists tried to address, of course (albeit in a misguided way), was not private property per se, but the problem associated with too few people having the means to participate in the institution. As G. K. Chesterton was to point out later, "Too much capitalism does not mean too many capitalists, but too few capitalists." (G. K. Chesterton, The Uses of Diversity (1921).)

New Things

The twin problems posed by both capitalism and socialism were the starting point of what many people of all religions consider one of the greatest wake-up calls to sanity in the 19th century. This was the encyclical, Rerum Novarum, "On Labor and Capital," which was issued in 1891 by Pope Leo XIII to address the "new things" (the translation of "rerum novarum") that had developed with the rise of industrial capitalism and the jettisoning of Say's Law and the real bills doctrine.

Arguably the first "social encyclical," Rerum Novarum analyzed current conditions for ordinary people, many of whom lacked any degree of ownership of the means of production. In a surprising and revolutionary turn of events, Rerum Novarum went beyond previous encyclicals by not only explaining what was wrong with the economic system, but by pointing out the obvious remedies.

The most important remedy to the propertyless condition was to make certain that people became owners. This was so important that the pope declared, "We have seen that this great labor question cannot be solved save by assuming as a principle that private ownership must be held sacred and inviolable. The law, therefore, should favor ownership, and its policy should be to induce as many as possible of the people to become owners." (Leo XIII, Rerum Novarum ("On Capital and Labor"), 1891, § 46.)

As we have seen was the case with the Homestead Act, widespread direct ownership of the means of production restores the operation of Say's Law. The Homestead Act, however, only addressed land, and thus resulted in only a partial restoration. Leo XIII addressed all forms of productive wealth, arguing, in effect, for a full restoration.

Nor was the goal of turning workers into owners to be achieved in any way that violated any else's rights. If "private ownership must be held sacred and inviolable," that meant for everybody, rich and poor alike, without distinction. A right that is a right only for some of the people some of the time cannot truly be said to be a right at all. When Leo XIII stressed over and over that private property is a natural right, then, he was making it very clear that redistribution of that which belongs by natural right to others is simply not an option — regardless how much someone else thinks they deserve it.

A basic principle of a well-run common good is that no one can have his or her life, liberty, or property taken away without just cause and without due process. Further, consistent with the philosophy of St. Thomas Aquinas (whom the pope had previously stated was the guiding philosophy for understanding the teachings of the Catholic Church), redefining a natural right or the exercise thereof so that the right itself is negated is neither just cause nor due process. (Rerum Novarum, op. cit., § 4.)

In response to the socialists, Leo XIII set out the natural right to be an owner very clearly: "Every man has by nature the right to possess property as his own. This is one of the chief points of distinction between man and the animal creation," (Ibid., § 6) as well as an equally clear exposition of what an owner can do with what he or she possesses, that is, the right of control and — most important for the restoration of Say's law — of disposal. (Ibid., § 5.) Why is "disposal" of property important for Say's Law? Because the power to draw a bill on the present value of what one owns, whether existing or future marketable goods and services, constitutes "disposing" of it.

Still Bound to Past Savings

The pope, however, made a tactical error in the encyclical. Leo XIII failed to take into account the fact that, consistent with the assumptions that have plagued the human race for thousands of years about how capital formation is financed, a great many experts and analysts would go unerringly off course. The inevitable tendency on the part of the usual authorities (inside and outside the Catholic Church) would be to take the pope's clear and unequivocal statements about private property and the natural right of everyone to be an owner of capital, and automatically assume the pope was calling for socialist redistribution or a continuation of monopoly capitalism. These are, in fact, the only possible alternatives if we limit ourselves to assuming that capital formation can only be financed out of existing accumulations of savings, regardless of our commitment or lack thereof to expanded capital ownership.

Not surprisingly, that is precisely what happened. The socialist read socialism in Rerum Novarum and all subsequent encyclicals, while the capitalist, to no one's surprise, saw an endorsement of capitalism. Trapped irrevocably in the belief that capital formation cannot be financed without recourse to existing accumulations of savings, both capitalists and socialists naturally ended up right back where they started.

Even Henry George weighed in on the debates stirred up by Rerum Novarum. In a 30,000-word "open letter" to Leo XIII, The Condition of Labor, (Henry George, On the Condition of Labor, September 11, 1891.) George did not, however, debate the issue so much as state his disagreement with Catholic teaching on private ownership of land and natural resources. To be fair, although not a Catholic, George was extremely polite and much more respectful of the Holy See than even many Catholics. George found himself able to agree on many of the teachings found in Rerum Novarum, and certainly all of the goals that Leo XIII said were desirable, even necessary.

George, however, disagreed strongly with the traditional teaching of the Catholic Church, based on the natural law that applies to the whole of humanity, that individuals as individuals have a natural right to own land and natural resources. Because George traced the problem of poverty and virtually all other social and economic ills to private property in the limited resources of land and natural resources, this meant that the Catholic Church was, in his opinion, failing to address the real cause of poverty.

To this day there are people who believe that Rerum Novarum either unfairly or unwisely dismisses socialism as the only viable alternative to capitalism, or creatively reinterpret the strictures against socialism in the encyclical to turn it into an endorsement of socialism. The only people possibly more active than the socialists in attempting to distort the natural law understanding of private property and the need for widespread ownership of the means of production are the capitalists.

Thus, despite the flaws that Leo XIII could see in the system as it existed in 1891, there was no real appreciation of the remedy: widespread direct ownership of the means of production. This was, as we have seen, both a systemic and a theoretical problem caused by adherence to the tenets of the Currency School and the consequent rejection of Say's Law and the real bills doctrine.

Does this mean that the pope or the Catholic Church is to blame for what was soon to come? Hardly. Catholics believe the pope to be infallible — but only in matters of faith and morals, and then only when teaching something intended to be understood as infallible. Applications of economic theory, while necessarily based on moral absolutes, are not themselves absolutes.

For example, the principle that every human being has the natural right to be an owner is absolute, and was stated as such by Leo XIII. How people are to exercise that ownership, and (more important with respect to the objective of restoring Say's Law) how they are to gain that ownership is a matter for human judgment — and human beings can be wrong.

Thus, when forty years later Pius XI reemphasized the importance of workers becoming owners, he was simply repeating an application of an infallible moral absolute: the natural right every human being has to be an owner of the means of production. (Quadragesimo Anno ("On the Restructuring of the Social Order"), 1931, §§ 58-59) He then made a human — and, frankly, flawed — judgment as to how workers were to acquire ownership: cut consumption, accumulate money savings, then invest. (Ibid., § 61) The papal encyclicals at one and the same time stressed the importance of the restoration of Say's Law as a moral imperative, then inserted a fallible human judgment that, if adhered to, made the restoration of Say's Law impossible.

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Say's Law of Markets, Part XII: An Economically Divided Democracy

If Abraham Lincoln's Homestead Act did nothing else, it confirmed that Say's Law of Markets and the real bills doctrine will not function when ordinary people do not have democratic access to the means of acquiring and possessing private property in the means of production, whether land, labor, or capital. The essence of Say's Law is that we do not purchase what others produce with "money," but with what we ourselves produce by means of our labor, capital, or land. When access to any one of these is cut off, Say's Law will not operate, or will function inadequately at best.

Restoring Say's Law

In an economy in which human labor is the predominant means of production, ownership of land or capital vests the possessor with a great deal of power — but not as much as might otherwise be presumed. In a labor-centric economy, land or capital is essentially worthless without the addition of labor, as Adam Smith pointed out in his "invisible hand" argument. Nevertheless, access to capital — technology — is necessary as well, or even the greatest labor expended on land will have little effect.

This is because the effect of technology (capital) is to replace labor, not supplement or enhance it; technology is a substitute for labor, not an addition to labor. As technology advances, labor becomes relatively less valuable as a factor of production. It becomes essential, then, that people who formerly relied on labor alone to generate an adequate and secure income must replace the income capacity of labor with capital and land.

Land, however, is (as we have seen) limited. That leaves only capital as a replacement for the income generating capacity of labor — and democratic access to a financial system that can turn the present value of existing and future marketable goods and services into "money" so that exchanges can be made.

Therein lay the real failure — or, at least, partial success — of the Homestead Act. The Emancipation Proclamation of 1863 and the 13th Amendment made all labor nominally free, while the Homestead Act made some land available without having to accumulate savings. Obtaining the technology necessary to make the land and labor effective, however, still required most people to cut consumption, save, then invest before purchasing capital. There was also no effective means whereby the Homesteaders could tie into the marketing and distribution of their crops, or gain an ownership stake in the industrial and commercial frontier to complement their ownership of land and labor. Under this arrangement of the economy and the financial system, Say's Law could only be partially restored — and then only as long as there was "free" land.

An Economy Divided

The rising "capitalist" class, of course, generally had no problem persuading a bank to discount its notes to finance the new factories and, especially, the railroads. The farmer and the small artisan, however, generally could only obtain credit by mortgaging what he or she already owned — hence the "first principle" of finance being the ability to distinguish between a bill of exchange based on the present value of existing and future marketable goods and services to be produced, and a mortgage based on the present value of an owned asset. (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.)

Lack of democratic access to land and capital as well as labor exaggerated a conflict that had always existed, but which gained force as society was now beginning to be sharply divided into three classes. These were, one, the growing number of propertyless workers: the proletariat. These were dependent wholly on selling their labor to gain an income. As a general rule, the only credit available to members of this class was and remains consumer credit. Consumer credit, along with government expenditures is usurious, "usury" being the taking of a profit when no profit has been generated. The nature of consumer and government credit is that the proceeds of a loan are not expended on something that pays for itself.

Two, there was the class of small owners, consisting of farmers, small ranchers, artisans, and shopkeepers. This class depended on profits from ownership, frequently supplemented with temporary or part-time wage system employment, to gain an income. Before the Industrial Revolution, these small owners had, in large measure, been the backbone of the economy. As technology advanced, however, and non-landed capital became increasingly and, finally, prohibitively expensive, the small owner was faced with three choices: 1) Not take advantage of the new technology and become non-competitive. 2) Gain access to technology only on extremely unfavorable terms, e.g., access to rail freight that cost the small owner much more per mile than the large owner. 3) Surrender ownership and become a member of the proletariat. In general, the only credit available to members of this class was consumer credit or mortgage-backed debt.

Three, there was the rising capitalist class, consisting of large ranchers, industrialists, and commercial interests, which last included freighting and shipping. While there might be some token wages or salaries paid to members of this class — American industrial folklore abounds in stories of extremely wealthy capitalists who were paid a "salary" of $1.00 per year — the vast bulk of the income received by this class consisted of profits of ownership: "interest" in classical economics. (In the classical analytical framework, "wages" go to labor, "rent" goes to the landowner, and "interest" goes to the owner of capital, thereby matching outputs to the three classic inputs of labor, land, and capital.)

As long as the credit of a member of the capitalist class was "good," he or she usually had the capacity to draw bills of exchange on the present value of existing and future marketable goods and services. He or she could then either use the bill as money directly, discounting and rediscounting with other businesses, or discount the paper at a commercial bank in exchange for banknotes or demand deposits. It was in this manner that the great industrial and commercial expansion of the latter half of the 19th century was financed. Members of this class rarely used consumer credit as anything more than a convenience (often a necessity for the proletariat), while a mortgage loan (usually the only type of credit available to the small owner) was frequently viewed as an admission that someone's credit was either deteriorating or already gone.

The Birth of a Nation

It was thus becoming critical that the financial system be restructured, both to open up democratic access to capital credit that did not rely on existing accumulations of savings, and to ensure that the money supply be both sound and adequate for the needs of agriculture, industry, and commerce. Neither was done.

Instead, the United States and Great Britain — arguably the two greatest industrial and commercial powers of the latter half of the 19th century — took a wrong path. Based on an incorrect understanding of money, credit, banking, and finance, concentrated ownership of the means of production became perceived as the only way in which society could advance economically.

Basing the whole of the money supply on existing savings meant that "money" itself had to be redefined. Bills of exchange could not be recognized as money because many of them were based on the present value of future marketable goods and services. That is, because the marketable goods and services did not yet exist, the bill was based on the general "creditworthiness" of the drawer of the bill, not the drawer's existing accumulation of money savings.

Due in large measure to the British Bank Charter Act of 1844 and the United States National Bank Act of 1863, however, government monetary and fiscal policy, as well as large sectors of the financial system were implemented or employed in a way that ignored the bulk of the money supply. Officially (and incorrectly), "money" was limited to meaning accumulated savings in currency form — even though, as Harold Moulton demonstrated in The Formation of Capital, money savings played a relatively small role in the economy, and almost no role in the financing of new capital formation.

Nevertheless, the redefinition of money (and thus credit) embedded the false notion that the "supply of loanable funds" (existing accumulations of savings) and the "production possibilities curve" (capital that could be financed out of existing savings without cutting consumption too much) imposed limits on economic growth — and who was permitted to participate in that growth. Basing economic growth on cutting consumption, accumulating money savings, and investing necessarily meant that there had to be a relatively small class of persons (and the smaller, the better) able to save without deprivation. As capital became increasingly expensive, so the rationale goes, so the rich presumably had to become ever-richer in order to finance the new capital.

All of this, of course, was based on the wrong definition of money that came out of the Currency School. By redefining money, Say's Law and the real bills doctrine had to be discarded, for they rely on "money" being anything that can be used in settlement of a debt, and limit the role of the State with respect to money to setting the standard of the currency and regulating it to ensure that it remains sound.

Democratic Elitism

Not only were there serious economic and financial consequences to the redefinition of money, however, the political system changed for the worse — although, confusingly, retaining the outward forms. This was, in fact, the theme of Walter Bagehot's The English Constitution (1867) and Lombard Street (1873), who divided the system in England into the "efficient" and the "dignified" forms, depending on whether he considered them practicable or just for show.

In the history of finance, Lombard Street qualifies as a brilliant examination of a system of banking and finance that assumes concentrated ownership of the means of production, oppression, exclusion, and the degradation of individual human dignity and personal sovereignty as a given. It is a classic of economic injustice, and the antithesis of the Homestead Act and Abraham Lincoln's vision of democracy as being a government "of the people, by the people, and for the people." Paradoxically, Lombard Street is lauded as a pillar of laissez faire capitalism, considered by its proponents to be the system that best embodies "freedom."

Lombard Street describes the operation of a financial system based on exclusionary barriers to participation, State control of the money supply, mercantilism, a permanent outstanding State "floating debt," and economic subjugation of colonies to the mother country, among a great number of other systemic violations of essential human dignity and personal sovereignty. Bagehot's book is, in short, a literary pillar and financial justification of the British Empire under the absolute rule of the House of Commons.

Not surprisingly, Lombard Street is an application of Bagehot's theories of sovereignty described in The English Constitution. In this, we can draw an analogy: The English Constitution is to Lombard Street, as Adam Smith's The Theory of Moral Sentiments (1759) is to The Wealth of Nations (1776). Both men applied their philosophical orientation more or less consistently in books that attempt to describe the way economic society works.

What Smith might consider an unfortunate but inevitable working of economic laws (actually a distortion of economic laws), however, Bagehot, and Keynes after him, regarded as the proper ordering of society. Like Keynes, Bagehot rejected the idea of democracy, while calling his system democratic. As Bagehot explained in The English Constitution — in which there is a single reference to Magna Carta, and that dismissive of basic human rights (Walter Bagehot, The English Constitution. Portland, Oregon: Sussex Academic Press, 1997, 154),

It is often said that men are ruled by their imaginations; but it would be truer to say they are governed by the weakness of their imaginations. The nature of a constitution, the action of an assembly, the play of parties, the unseen formation of a guiding opinion, are complex facts, difficult to know and easy to mistake. But the action of a single will, the fiat of a single mind, are easy ideas: anybody can make them out, and no one can ever forget them. When you put before the mass of mankind the question, "Will you be governed by a king, or will you be governed by a constitution? the inquiry comes out thus — "Will you be governed in a way you understand, or will you be governed in a way you do not understand?" (Ibid., 21)

In other words, most people are simply too stupid and incompetent to be able to govern themselves. They need a political and financial elite, endowed as such by a Creator, to make decisions and run things for them. There is enough anti-American sentiment expressed in The English Constitution to justify the impression that Bagehot loathed the United States and everything for which it stood.

It is hardly a matter for comment that, in light of his orientation, Bagehot made approving noises regarding the political theories of Thomas Hobbes, (ibid., 120) the totalitarian political philosopher. Bagehot ignored completely both John Locke and Algernon Sidney, two thinkers somewhat more in tune with human nature, and thus having a great deal more respect for human dignity. Locke and Sidney, along with Charles-Louis de Secondat, baron de La Brède et de Montesquieu, were significant influences on the American Founding Fathers and framers of the U.S. constitution.

Montesquieu (1689-1755) was a French social and political commentator who wrote The Spirit of Laws, which was used by the American Founding Fathers as a virtual textbook on government. Montesquieu was a strong advocate of separation of powers, a concept explicitly rejected by Bagehot, who ridiculed the idea of checks and balances: "Hobbes told us long ago, and everybody now understands, that there must be a supreme authority, a conclusive power, in every State on every point somewhere." (Ibid.)

Bagehot then went on to attack the U.S. Constitution, indeed, the entire American political system, at one point calling one of its important institutions a "farce." (Ibid., 15) This makes it all the more surprising that many of today's political scientists and economists view Bagehot in a very favorable light, (Bruce Ackerman, "Obama, Warren and The Imperial Presidency," The Wall Street Journal, 09/22/10, A21) even though Bagehot rejected sovereignty of the people against an absolute monarch or totalitarian State, and thought the divided sovereignties between the states and the federal government, and checks and balances to secure oversight and accountability, ludicrous concepts.

The Political Theory of Capitalism

A reading of The English Constitution — a virtual necessity if one is to understand Lombard Street — gives a very clear exposition of Bagehot's position. A relatively small elite — the "Upper Ten Thousand" as they were called — were in control of the country, and (according to Bagehot) properly so. Bagehot carefully distinguished leadership in "society" (meaning parties, balls, race meets, and so on) from leadership in government and the economy. The Queen (a "retired widow") and the Prince of Wales ("an unemployed youth") are the leaders of society and play an important role in providing the lower classes with the easily understood fallacy that the monarch rules the country. Bagehot called this the "dignified" aspect of the English Constitution, a social convention to pacify the unintelligent masses.

The real power resided in the House of Commons, the House of Lords being another "dignified" aspect of the Constitution of the country. The House of Commons is "efficient" as opposed to "dignified," and, so far as the traditional structures of government allowed, ran the country essentially as a business corporation. The propertied classes were (in a sense) the shareholders of the national corporation. Common unpropertied people, as well as aristocrats whose wealth and power were in decline as agriculture diminished in relative importance, were to some extent supernumeraries, redundant employees and pensioners of the national corporate State.

The House of Commons, elected by a relatively small number of voters, was, essentially, the board of directors of the country, "a class . . . trained to thought, full of money, and yet trained to business." (The English Constitution, op. cit., 66.) In other words, the governing body of the Empire was a carbon copy of the owners and upper management of the East India Company, a private enterprise that governed India for the Crown until 1858, eight years before Bagehot wrote The English Constitution.

Do not assume, due to his assertion that ultimate power resided in the House of Commons, that Bagehot supported popular sovereignty. It must clearly be understood that the electorate at the time he wrote, 1867, was extremely small, and composed exclusively of men of property, a financial elite which thereby secured a self-perpetuating political power — the "pocket (or "rotten") borough" system. This was only right, for Bagehot believed that the masses are too stupid to be able to vote or do anything other than take orders:

• "We have in a great community like England crowds of people scarcely more civilized than the majority of two thousand years ago; we have others, even more numerous, such as the best people were a thousand years since. The lower orders, the middle orders, are still, when tried by what is the standard of the educated 'ten thousand', narrow-minded, unintelligent, incurious." (Ibid., 6)

• "We have whole classes unable to comprehend the idea of a constitution." (Ibid., 23)

• "A free nation rarely can be — and the English nation is not — quick of apprehension." (Ibid., 74)

As Bagehot declared, "The principle of popular government is that the supreme power, the determining efficacy in matters political, resides in the people — not necessarily or commonly in the whole people, in the numerical majority, but in a chosen people, a picked and selected people." (Ibid., 17) [Emphasis in original.] Not surprisingly, one of the "defects" Bagehot listed in the American system is the impossibility of a dictatorship in times of national emergency. (Ibid., 20) Another problem is that Americans do not accept the opinions of their betters without question: "They have not a public opinion finished and chastened as that of the English has been finished and chastened." (Ibid., 13.)

Natural rights, the judiciary, — such things are ignored. They are unimportant because they are not "efficient," that is, they do not increase the effectiveness of government, the purpose of which is to protect the interests of the propertied classes who run the country. Weaknesses appear in government to the extent that the State administration departs from the principles of business, e.g., lack of efficient structure, redundancy, etc. The fact that these structures were at least initially intended to provide accountability to the citizens is irrelevant. The capitalist of Bagehot's day was not accountable to his workforce or his customers, so the government should not be accountable to the citizens it governed.

Bagehot simply didn't understand that the State is not a business corporation owned by a small capitalist elite. While principles of sound business (as opposed to the diseased structures that have grown up to support and protect capitalism and socialism) can be applied in government to great advantage, ultimately there comes a parting of the ways. A business corporation exists to make a profit and benefit the individual workers, shareholders, and customers, while a government exists to keep order and care for the common good; it is not an enterprise to be run for individual benefit or profit.

The Economic Theory of Capitalism

Bagehot's theories of sovereignty may have been derived from his economics and finance, detailed in Lombard Street: A Description of the Money Market. Bagehot asserted that he would have nothing much, if anything, to say about the Bank Charter Act of 1844 that congealed the tenets of the Currency School into British (and American) fiscal and monetary policy. The book assumed reliance on existing accumulations of savings as a given, indeed, the only possible arrangement of the financial system.

Banks of deposit are the only recognized financial institutions in Bagehot's framework. Consequently, economic power is as necessarily concentrated as political power. Although Bagehot is lauded as a champion of laissez faire economics, the system he described requires increasing levels of State interference to ensure the stability of that portion of the currency that is backed by government debt.

Further, Bagehot seemed unaware that allowing the State to "create" money to any degree or in any way, shape, or form was to ensure the intrusion of the State into virtually every area of life in order to try and force the system to work against its natural tendencies, and ultimately destroys the personal liberty of everyone, not just the unpropertied masses.

In the end, Bagehot's work did not break new ground. Instead, it provided a diagnosis of a system that was rapidly approaching non-sustainability. Bagehot's mistake was to assume that the system he described was not only acceptable, but somehow ideal.

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Book Review: Tom Kratman's "A State of Disobedience"

As threatened, here is a review of the book I happened to pick up at Border's a couple months ago. It was pure serendipity. Tom Kratman's A State of Disobedience is in the "military science fiction" subgenre a field with which I have become somewhat disenchanted for reasons that have nothing to do with this review. Nevertheless, I picked this book because 1) it was the author's first effort from 2003, and 2) from the back cover blurb it seemed less dreary than anything else I saw, and I was desperate to take a break from writing and read something new that didn't have anything to do with money, credit, banking, or finance.

Say's Law of Markets, Part XI: Homesteading and Say's Law

Two manifestations of private property effectively came to an end with the American Civil War. One of these is obvious: private property in human beings. This had always been somewhat equivocal, being originally justified as a way of dealing with criminals at a time when no labor could be spared, and the State did not have the social surplus to support convicts. The solution? Sell criminals as slaves to private owners. The other manifestation of private property that the Civil War undermined was the national currency.

All Money is Based on Private Property

At the danger of oversimplifying, since the invention of coinage and the expedient of having the State certify and regulate the currency, the money supply has been divided into two parts. The first part, and the one most familiar to most people as "money," is the currency: the official medium of exchange, to which the State lends its "full faith and credit" in order to give the public confidence that each unit of currency does, in fact, represent a private property claim to the value of the amount stated on the face, and will be accepted in payment of debts.

By far the larger part of the money supply even today, however, does not take the form of currency. Instead, as we have seen, this "private sector" money supply (that is, not regulated or certified by the State) consists of bills of exchange in a bewildering array of forms, from a handshake to a notarized promissory note. These "credit instruments" may or may not be denominated in the national currency units. They often circulate, however, in the process becoming a kind of quasi currency, by holders in due course using the instruments to settle debts. The instrument passes from hand to hand until maturity, offered at a discount or, in some cases, a premium, depending on the present value of the goods or services exchanged by means of the note. At maturity, of course, they are redeemed at the full face value, or the good credit of the issuer suffers. This is Say's Law of Markets as applied in the real bills doctrine.

The private property basis of bills of exchange is obvious when we stop to think about it. Someone who draws a bill either has on hand marketable goods or services with a present value in the face amount of the bill, or reasonably expects to have those goods or services (or, in some cases, the value thereof in currency) on hand in order to redeem the bill when presented for payment. That is, for a bill to be a "real bill" and not "fictitious," the drawer of the bill must own that on which he or she draws the bill.

The private property basis of the State certified and regulated currency is (or should be) no less obvious. When the currency consists of gold and silver, it is clear that the State must purchase the gold and silver from those who possess it before it can be manufactured into coin. Similarly, when a bank has the right to issue banknotes or create demand deposits denominated in the national currency with the State's sanction, the bank must purchase bills of exchange, paying for the bills with the new banknotes or demand deposits.

Obviously, the bank is not really creating money by doing this, but changing one form of money issued by a private person and not certified or regulated by the State, for a form of money that is certified and regulated by the State. Nevertheless, the original drawer of the bill must own the present value on which he or she draws the bill, or he or she is committing fraud.

Similarly, when the State sanctions the creation of money backed only by government debt, the State is using "fictitious bills." This is because the State does not own the future production of goods and services that it must tax if the government securities are to be redeemed and the new money retain its value. As Paul Samuelson is reputed to have said, the State in this wise engages in "legal counterfeiting," that is, making promises backed by what the State does not own that future taxpayers are forced to keep.

This substantiates that money, properly understood, is a right of private property, the "right of disposal." Drawing a bill on something you own is one way of disposing of your assets. It is by this means that you exchange what you produce (per Say's Law) for what others produce through the medium of exchange. When the bill is presented for redemption, the drawer turns over the assets that backed the bill, and the contract (debt) created by drawing the bill is fulfilled, and the transaction completed.

Violating Social Justice

All of this highlights the most serious problem with Secretary Chase's chosen method of financing the war — sacrificing the common good for his personal advantage: political popularity. By using debt instead of taxes, consumer prices doubled in short order. (Conant, op. cit., 403-404; Moulton, op. cit., 116-117.) As Charles Conant described the situation, "Secretary Chase made the fatal mistake at the outset of relying upon loans to supply the means of carrying on the war instead of appealing to the productive resources and the patriotism of the people." (Conant, op. cit., 403.)

In other words, Chase would have done much better had he decided to finance the war from the first by raising direct taxes instead of using the "hidden tax" of inflation. This would have given the productive potential of the North full rein instead of draining it of reserves of sound money and financial capital. The private sector could have used the available credit to expand production, thereby increasing the tax base, and the national credit and private productive capacity would not have been put into the position of near-bankruptcy. As one authority pointed out, "That if an irredeemable paper currency was the inevitable resort, it would be more expedient and economical for the government not to become involved in its dangers, but to impose the duty and responsibility of issuing the notes upon the banks, who would naturally be compelled to keep the day of redemption continually in view." (George S. Coe, "Financial History of the War," Bankers' Magazine, January 1876, quoted in Conant, ibid., 402.)

An interesting side note that reveals Chase's supreme arrogance and lust for total power (he was bitterly disappointed that the Republican Party passed him over in favor of Lincoln) are the designs that Chase put forward for the first issue of United States Notes, the "greenbacks." ("Salmon Portland Chase," Encyclopedia Britannica, 1911 edition.) To advance his political career, he had his own portrait put on the dollar bill so that more people could become familiar with his face.

The National Bank System

It was not until 1863 that Chase woke up to the situation that he had created. A sweeping reform of federal finances and the banking system was hurried through Congress with the National Bank Act of 1863. Having put the country into debt up to its neck and beyond, Chase decided to switch to raising taxes to defray the cost of the war. Besides, the government's lines of credit were pretty much exhausted, and he didn't have any choice. As a result, Chase suddenly announced his decision to provide "for the largest possible amount of extraordinary expenditures by taxation." (Conant, op. cit., 403.) Tax collections from 1861/62 through 1865/66 (the federal government fiscal year ended on June 30) show the effect of Chase's change in policy, from just short of $52 million in 1862, to more than half a billion in 1866. (Conant, ibid., 403.)

Having virtually wrecked the credit of the United States and flooded the country with a badly inflated currency, Chase was determined to implement a system that would allow the federal government to control the issuance of all banknotes and retain its power to borrow. This was in direct contravention of Say's Law and the real bills doctrine, and after the dangers of debt financing for a non-productive entity like the State had been demonstrated in the most graphic manner possible. "But the Secretary declined to entertain this suggestion [to finance the war through taxes and allowing private banks to use available credit to finance increased production instead of for government borrowing]; preferring the system of national banks which he had already conceived." (Ibid., 402)

As hinted in the preceding paragraph, following the lead of the British Currency School that rejected Say's Law and forced through the Bank Charter Act of 1844, Chase had already devised a system based on his belief that 1) banknotes represented a non-interest bearing loan from the people to the banks, and 2) the State, instead of the stockbrokers who handled the issues of private securities that backed the banknotes, should receive the non-existent interest.

Chase did not explain how, at one and the same time, a loan made via banknotes was both interest-free and paid interest. He believed that the federal government could be financed and the currency stabilized by 1) permitting banknote issue only by banks belonging to a national system, 2) with fractional reserves of specie, and 3) only to the extent that the banknotes were backed by interest-bearing government bonds. His issuances of United States Notes were the first step in the establishment of this system, (Ibid., 405) and of a permanent, interest-bearing outstanding federal debt. (Many monetary theorists have somehow ignored historical facts and Chase's stated program in their assertions that the so-called "Lincoln Money" was intended from the first to be non-interest bearing and not involve the issue of bonds.) According to Chase, the advantages were:

• "A circulation of notes bearing a common impression and authenticated by a common authority;"

• "The redemption of these notes by the associations and institutions to which they may be delivered for issue;" and

• "The security of that redemption by the pledge of United State [sic] stocks, and an adequate provision of specie." (The contradictory goals are Chase's own words, taken verbatim from Report to the Finances, 1861, 19, quoted in Conant, op. cit., 405.)

In other words, 1) all notes would look the same, 2) the banks, not the federal government would redeem the notes, and 3) all banknotes would be subject to a 100% reserve requirement, primarily in the form of government debt, but with sufficient amounts of specie to supply any demands for redemption in gold or silver — in reality, "fractional reserve banking."

A genuine 100% reserve requirement, of course, would have meant that the backing of the notes was in the form of assets, whether gold and silver, or liens on productive capital financed with the issue of banknotes. What Chase proposed was a primarily debt-backed, as opposed to asset-backed currency, with fractional asset reserves in the form of gold and silver to meet any demands for "real" or "lawful" money.

Although Chase clearly had such a scheme in mind as early as 1861, it was not until late 1862, when he had put the country in an extremely shaky financial position, that he was able to complete his plans. Perhaps not surprisingly, Chase's language explaining his proposal in his 1862 Report on the Finances (Report on the Finances, 1861, Ch. xxiii, quoted in Conant, ibid., 406.) bears a striking resemblance to that of Honoré Gabriel Riqueti de Mirabeau (1749-1791) when proposing the issuance of assignats by the revolutionary government to the French Assembly in what was considered Mirabeau's most impassioned speeches: (Michael J. Kosares, "Fiat Money Inflation: Then and Now," http://www.usagold.com/gildedopinion/assignats.html.)

Every dollar of circulation would represent real capital, actually invested in national stocks, and the total amount issued could always be easily and quickly ascertained from the books of the Treasury. These circumstances, if they might not wholly remove the temptation to excessive issues, would certainly reduce it to the lowest point, while the form of the notes, the uniformity of devices, the signatures of national officers, and the imprint of the national seal authenticating the declaration borne on each that it is secured by bonds which represent the faith and capital of the whole country, could not fail to make every note as good in any part of the world as the best known and best esteemed national securities. (Report on the Finances, 1862, 18, quoted in Conant, ibid., 406-407.)

Contrary to Chase's assertion, government securities do not "represent real capital," that is, claims on the present value of existing or future assets. On the contrary, government securities are nothing more than debt — a debt secured by future tax revenues that may or may not be collectible. The country's financial position being extremely precarious at this point, Chase's bill was pushed through very quickly, and signed into law by President Lincoln as the National Bank Act of 1863 on February 25, 1863. (Ch. 58, 12 Stat. 665, February 25, 1863.) The Act, however, contained serious flaws, and was superceded by the fundamentally similar National Bank Act of 1864, June 3, 1864. The essential provisions of the Act were:

• Circulating notes should be issued by a new "Comptroller of the Currency" upon deposits of United States bonds, to the amount of ninety percent of the face value of the bonds.

• No national bank could be organized with less than $100,000 in capital, except where the population did not exceed 6,000, in which case a bank could organized with the approval of the Secretary of the Treasury with not less than $50,000.

• Half the capital was to be paid in before starting business, with the balance paid in installments.

• A bank had to deposit the greater of $30,000 or one-third of the bank's capital with the federal government to purchase government bonds, receiving banknotes in exchange.

• The National Bank Notes were redeemable in "lawful money." (Conant, ibid., 407-408.)

The amount of government bonds a National Bank was required to purchase to back its note issues was adjusted several times. The banknotes given in exchange functioned as the bank's reserves, a paper currency for which the bank had paid hard money in the form of gold and silver coin. The "redeemable in lawful money" provision, however, was more than a little misleading. A National Bank was not required to hand over either gold or silver in exchange for the National Bank Notes it purchased from the government.

The "lawful money" to which the Act referred — thanks to New York Congressman Elbridge Gerry Spaulding's (1809-1897) drafting of the legal tender law that, in effect, turned paper into the legal equivalent of gold and silver (Ibid., 407) — was nothing more than the badly depreciated United States Notes. Thus, the "redemption" consisted of exchanging one government obligation for another. The sole advantage to this to the public was to make the United States Notes and the National Bank Notes pass at par with one another — an effective raise in the value of the United States Notes, and a lowering of the value of the National Bank Notes. (Ibid., 408-409)

Fortunately, Chase's adherence to the principles of the British Currency School ensured that nothing other than gold and silver coin, and banknotes backed either with gold and silver coin or government debt (primarily government debt) were considered "real" money. The private sector could continue, as in Great Britain, to use "non-monetary" checks, bank drafts, bills of exchange, bankers' and merchants' acceptances, letters of credit, and all the other financial vehicles that constitute the real money supply far in excess of the paper or metallic legal tender currency. (Cf. George Tucker's statistics in The Theory of Money & Banks Investigated (1839), 132; Fullarton, op. cit., 29.)

The Homestead Act

In spite of all these financial shenanigans, falsely attributed to Abraham Lincoln, the United States at this time rather paradoxically managed to implement one of the most advanced programs ever devised to build ownership of productive assets into ordinary people. This initiative — for which Lincoln was responsible — is credited with providing the foundation for America's growth as a world power. It also:

• Reinforced the basic American mythos of the United States as a nation of owners,

• Built a broad-based consumer constituency with independent incomes not tied to wage-system jobs, and

• Provided the critical increase in demand on which America's immense industrial growth during the latter half of the 19th century was built. (Moulton, The Formation of Capital, op. cit., 47-48)

This initiative was, of course, Abraham Lincoln's 1862 Homestead Act. The Act has been called one of the most important pieces of legislation in the history of the United States. In the absence of democratic access to bank credit — the chief means of acquiring and possessing private property in the means of production in an industrial economy — the "free" land opened up for settlement by the Homestead Act ensured that Say's Law would operate for the agricultural sector without the immediate necessity for the real bills doctrine.

The real bills doctrine, of course, was essential not only to ensure the full success of the Homestead Act (the land was "free," but the Homesteaders still needed credit to purchase seed, equipment, and supplies), but to finance the industrial growth and the eastern markets that absorbed the new production from the west. In any event, by means of the Homestead Act, the vast holdings of federal land were turned over to the citizens on remarkably easy terms:

• Anyone who was a citizen or declared the intention to become a citizen and was twenty-one years of age or older and paid the $18 filing fee was eligible.

• Each eligible person was entitled to a quarter section — 160 acres (which could be increased to a full section, 640 acres, in certain areas).

• Build and maintain a one-room dwelling and "improve" the land.

• Stay in residence for five years.

Approximately 270 million acres, or 10% of the total land area of the United States was claimed and settled on these terms before the Act was terminated in 1976 (with Alaska extended to 1986).

There were, as today's academics and politicians are quick to point out, serious flaws in the Homestead Act. There was fraud, inappropriate use of land, relatively few people compared with the total population of the United States took advantage of the opportunity, and so on, and so forth. Recently, claims have been made that the 160 acre quarter sections were sub-economic, that is, insufficient to provide families with an adequate and secure income, that the program itself was bad for the ecology and the economy, and it gave people the impression that it is possible to gain income in an advanced modern industrial economy without dependence on an employer.

The Real Flaw in the Homestead Act

All of these critiques (and more), however, while very supportive of both capitalism and socialism, miss the two biggest flaws in the Homestead Act — as well as the very real advantages that the Act conferred. First, of course, there is the obvious problem that the amount of land is strictly limited. It is virtually impossible, in the ordinary course of events, to create new land and depletable natural resources. This was the concern addressed by Henry George in his treatise, Progress and Poverty (1879). To solve this dilemma, George advocated the effective abolition of private property in land by having the State take away any incentive to own land by taxing away all profits on land as land. As George summarized his proposal,

What I, therefore, propose, as the simple yet sovereign remedy, which will raise wages, increase the earnings of capital, extirpate pauperism, abolish poverty, give remunerative employment to whoever wishes it, afford free scope to human powers, lessen crime, elevate morals, and taste, and intelligence, purify government and carry civilization to yet nobler heights, is — to appropriate rent by taxation.

In this way the State may become the universal landlord without calling herself so, and without assuming a single new function. In form, the ownership of land would remain just as now. No owner of land need be dispossessed, and no restriction need be placed upon the amount of land any one could hold. For, rent being taken by the State in taxes, land, no matter in whose name it stood, or in what parcels it was held, would be really common property, and every member of the community would participate in the advantages of its ownership. (Henry George, Progress and Poverty (1879), 405-406.)

Henry George's goals, however, can be achieved without recourse to State ownership, effective or actual. All the citizens or residents of a geographical area can become direct owners of the land, natural resources, and infrastructure through a "Citizens' Land Bank" or similar vehicle. They can thereby become actual owners in fact, as opposed to theoretical owners through the State. No, limited land and natural resources, serious as it was and remains, was not the most important flaw in the Homestead Act.

The problem was that the Act did not address the increasingly critical need for widespread ownership of industrial and commercial assets. The ownership of America's new industries and commerce was, compared with the ownership of land, a virtual monopoly. The concentration of ownership was increasing almost by the day as America's industrial and commercial base expanded with incredible rapidity in the decades following the Civil War.

As Kelso and Adler were to explain in The New Capitalists, the increasing concentration of ownership of industrial and commercial capital was the result of the way in which capital formation was financed. The reliance on existing accumulations of savings, termed "slavery" by Kelso and Adler in no uncertain terms, ensured that ownership of virtually all new capital formed would go to those who already owned most of it in the first place.

This is due to the fixed belief (as false as it is unshakeable) that investors use their savings directly to finance capital formation, and the fixed reality that no reputable or honest bank will lend money for even the soundest capital project without adequate collateral. Consequently, ownership of the means of production is, given an absolute and dogmatic faith in these constraints, properly a monopoly of a financial or economic elite — which is also (if things are to be run "properly") the political elite as well.

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