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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