Yesterday (Tuesday, December 7, 2010), Dr. Norman G. Kurland and Michael D. Greaney, President and Director of Research for CESJ, respectively, attended the launching of Dr. Judy Shelton's pamphlet, A Guide to Sound Money, sponsored by the Atlas Economic Research Foundation and FreedomWorks. The midday event, "Sound Money and America's Global Economic Leadership," featured brief presentations by Matt Kibbe, President and CEO of FreedomWorks Foundation, Alejandro Chafuen, President of the Atlas Economic Research Foundation, Representative Mike Pence of Indiana, Dr. Judy Shelton, Co-Director of the Atlas Foundation's Sound Money Project, Representative Paul Ryan of Wisconsin, Dr. Lawrence White of the Economics Department of George Mason University, an unscheduled presentation by Jimmy Kemp, son of the late Jack Kemp, and closing remarks by Brad Lips, CEO of Atlas.
Dr. Shelton's pamphlet is being widely distributed in an effort to educate as many people as possible about the dangers of deficit spending in general, and current monetary policy in particular. The orientation is that of the "Austrian school" of economics, which — of the three "mainstream" schools of economics — is the closest to the natural law principles of the Just Third Way, the "four pillars of an economically just society":
1. A limited economic role for the State,
2. Free and open markets within a strict juridical order as the best way of determining just wages, just prices, and just profits,
3. Restoration of the rights of private property, especially in corporate equity, and
4. Widespread direct ownership of the means of production, especially through democratic access to money and credit creation for productive purposes.
This last — widespread direct ownership of capital — is the "fatal omission" from all mainstream economics and finance, including the Austrian school. Sadly, the few schools of economics that do recognize the importance of widespread ownership (with the notable exception of Binary Economics), tend to undermine one or more of the other natural law pillars. Usually this is by redefining the natural right to be an owner ("private property"), but freedom of association (liberty/contract) comes in for its share of redefinition, as does individual sovereignty through the tendency to give the State far too great a role. Primarily the State gains increasing power these days by exercising its alleged "right" (in the words of John Maynard Keynes) to "re-edit the dictionary" (A Treatise on Money, Volume I: The Pure Theory of Money, 1930). This "right" allows the State to abolish presumably inalienable rights to life, liberty, property and the pursuit of happiness on anything other than the State's own terms by redefinition of these basics of human existence.
This highlights the one problem we found in Dr. Shelton's pamphlet. There was practically nothing said with which we could disagree — except for the claim on page 7 that, "Free market capitalism depends on people's willingness to forego consumption today to provide the resources that will enable a greater standard of living in future years."
Regular readers of this blog will instantly recognize the problem here. It is, after all, the main "selling point" for Binary Economics, and the underpinning of the monetary and fiscal reforms found in "Capital Homesteading" and highlighted in the subtitle of Louis Kelso and Mortimer Adler's second collaboration, The New Capitalists: "A Proposal to Free Economic Growth from the Slavery of [Past] Savings."
Dr. Shelton's statement strikes at the heart of Say's Law of Markets implicit in Adam Smith's "invisible hand" concept, and that finds its application in the real bills doctrine. Not surprisingly, it is based on the partial understanding of money and credit found in the tenets of the British Currency School of finance, that "money" consists of coin, banknotes, and demand deposits . . . although some Currency School purists reject as "money" anything that is not coin or banknotes backed by specie (gold or silver).
The Currency School understanding of money fits into the standard economic definition of money (very briefly, the medium of exchange and a store of value). It does not, however, fit into the legal or accounting definition of money: anything that can be used in settlement of a debt. Precisely stated, the economic definition of money describes money by its function, while the legal and accounting definition of money (the Banking School of finance) defines money by its nature.
This distinction is critical. For thousands of years before the invention of coined money, trade was carried out by means of bills of exchange and derivatives of bills of exchange, such as promissory notes and drafts. These were contracts into which parties to the transaction entered freely. The State could enforce or arbitrate contracts and to a certain extent dictate what constituted legal or allowable matter of a contract, but it could not in general dictate the terms of a contract or unilaterally change the terms of a contract to which it was not a party. The idea of "contract" is important in this discussion, because all money constitutes a contract, and all valid contracts in a sense constitute money.
"Money" properly defined, then, is anything — repeat, anything — that is used in settlement of a debt. Even today, when the State has extended its power to virtually the whole of economic and political life, the bulk of the money supply consists of private sector bills of exchange in various forms, not State-issued coin, currency, or demand deposits. Dr. Shelton hints at this on page 5 ("Transactions take place only if that piece of paper means something to both parties. The individual who receives it must be just as aware of the paper's value as the one who gives it; when the paper has been exchanged, both parties know that a deal has been struck at a specific price."), but the point gets buried under the functional definition of money.
The fact is that the State discovered very soon after the invention of coined money and the State's assumption of the regulatory and certification authority over money that it could alter the terms of any contract simply by manipulating the "underlying," or asset behind the derivative. That is, all money is a derivative of the issuer's (or contract maker's) private property right in something of value that is being conveyed by means of the money. Broadly, "money" thus represents a private property stake in the present value of an existing or future marketable (exchangeable) good or service — a "derivative" or (in older parlance) a "real bill." "Currency" is a specific form of money, a derivative of a real bill, or a derivative of a derivative. This is legitimate and sound as long as the underlying at each stage is not itself used as money . . . and it actually exists at or greater than the value conveyed in the derivative.
Unfortunately, the State quickly found that it could make a "profit" (actually, incur a liability — the confusion results from people who don't understand the balance sheet or the income statement) by saying that there was "X" amount of gold or silver in a coin, but put "X - Y" worth of gold or silver in the coin. Today, matters have reached such a pitch that the State issues countless certificates announcing how many "dollars" each certificate represents, but without having a private property stake in the present value of existing and future marketable goods and services that the certificates represent. This robs possessors of wealth denominated in units of currency by decreasing the value of the currency through inflation, and transfers that value to the issuer of the currency — the State.
The effect of recognizing only State-issued certificates backed by nothing other than future tax revenues ("anticipation notes") as money has a number of very bad effects. One, it limits the "supply of loanable funds" to existing accumulations of monetary savings. These being a monopoly of the rich by definition, the State feels compelled either to redistribute wealth directly, or through inflation, by both means undermining private property.
Two, money and credit become viewed as a commodity in and of itself, in limited supply, while "interest" changes from an owner's enjoyment of the natural right to enjoy the fruits of ownership by participating in profits, to a charge for the use of money. The State is rarely able to keep itself from manipulating the interest rate, either by taxing away "unjust" or "excess" gains for redistribution, or by imposing a desired rate of return directly.
Three, the amount of new investment is limited not by available resources, effective demand, or financially feasible projects, but by the amount of existing savings in the system. This infringes on freedom of association (liberty), for (money being a contract) to require that investment in new capital only be financed out of the present value of existing marketable goods and services saved out of consumption means that people are prevented from making contracts involving the present value of future deliverables.
Four (and most critically), since (as we noted) existing savings are a virtual monopoly of the wealthy, and all financing for new capital presumably comes out of existing savings (it actually doesn't, but that's a story for another day), those who are most in need of capital ownership to supplement or replace the declining value of their labor as technology advances are shut out of ownership.
There are many other problems associated with reliance on existing accumulations of savings to finance new capital formation, but that's enough for now. The question we need to address is how best to supply money to the economy so as to ensure an adequate amount that at the same time retains its value and fills all the other necessary functions of the medium of exchange, so well covered in Dr. Shelton's pamphlet. (Yes, it may appear as if we're picking on her, but we're just pointing out a serious flaw that we feel undermines the value of her important work.)
As described in The Formation of Capital (1935) by Dr. Harold G. Moulton, the best way to finance new capital formation that respects the free market as well as individual rights of private property and free association (liberty) is by expansion of commercial bank credit backed by financially feasible capital projects on which private sector enterprises and entrepreneurs have drawn bills of exchange. Backed up by a central bank to ensure uniformity and stability, as well as spread risk, currency and demand deposits backed by discounted and rediscounted bills of exchange results in an asset-backed, private sector issued (if State regulated), stable money supply that expands and contracts directly with the needs of the economy.