Wednesday, January 12, 2011

Some Capital Homesteading Questions, Part III: Qualified Investment

There is a big problem with advocating widespread capital ownership today. Many people share a virtually unquestioned assumption with "the experts" who really should know better. And that is? That the secondary market for debt and equity — "the stock market" — is actually the primary market and the chief means by which capital is allocated and new capital formation financed. That is simply not the case, as we have shown many times over the years on this blog, and is demonstrated in Dr. Harold G. Moulton's book, The Formation of Capital (1935).

While erroneous, this assumption leads directly in to the second question asked by our correspondent last week: "In what would the self-liquidating credit under a Homestead Act actually be invested in, in a climate such as the current one?"

Good question.

In an economic climate such as the current one, there are few, if any, feasible capital projects suitable for Capital Homesteading. This is because consumer demand has declined in response to the increase in unemployment and distortions of the financial system by the government and the "despotic economic dictatorship." (Quadragesimo Anno, §§ 105-106) The obvious solution to the current situation, then, is — to change the economic climate by organizing and carrying out acts of social justice. This is both easier and harder than it sounds.

First, what is needed is genuine stimulus in the form of an increase in real effective demand, i.e., freeing past savings from the slavery of capital formation, if you will. This is something of a chicken-or-the-egg situation. There are ongoing discussions on this topic in CESJ, and we have not yet decided on a likely scenario, so specifics of this response will probably vary slightly depending on who answers. Some of us think it might go something like this.

Ideally, the whole Capital Homestead package would be enacted at the same time. One of the features is the tax deductibility of dividends at the corporate level. Corporations retain earnings in order to finance future capital growth. (That's not what happens, but that's what most of the experts believe happens.)

In any event, because dividends are considered a distribution of equity and not an expense, they are a charge against retained earnings, not current income. Dividends under Capital Homesteading would, however, be tax deductible at the corporate level, thereby eliminating the "double tax" on corporate profits — and give a double benefit to shareholders: one, by encouraging boards of directors to give to the shareholders what is theirs by natural right of private property, and two, by removing the penalty imposed on property incomes paid out to those who have the right to receive it. There would be no reason for the corporation to retain earnings. The owners equity portion of the balance sheet should, ideally, consist only of a listing of actual equity instruments outstanding, with zero retained earnings.

With retained earnings thereby rendered "sterile," the only rational thing for a corporation to do would be to pay out retained earnings and take the tax deduction. This would provide a stimulus to the economy in the form of dividend income that cannot be reinvested, as all new capital formation would be financed by new issues of shares purchased with non-recourse credit, bundled and rediscounted at the regional Federal Reserves through the commercial banking system. The increase in effective demand resulting from paying out retained earnings would promote real job creation in the short run, just as increased government spending did artificially in World War II, and in the mid- to long-term paying out corporate earnings would ensure that consumption and production reach equilibrium, and there is full employment not just of labor, but of all financially feasible resources.

This is because tax deductibility of dividends would, obviously, encourage full payout of corporate earnings. The owners' equity portion of the Balance Sheet would, however, continue to increase, reflecting the general increase in wealth in the economy. It would not do this by increasing the wealth of existing owners, but by expanding the ownership base of the corporation to the same degree that the corporation would formerly have concentrated ownership. By shifting corporate finance from corporate debt secured by increases in retained earnings, to Capital Homesteading equity shares collateralized with capital credit insurance and reinsurance, the base of capital ownership in the economy would grow, more people would be less dependent on labor incomes alone, and effective (and sustainable) consumer demand would increase proportionately.

So, no, as things are currently structured, there isn't much out there in the way of feasible investment for Capital Homesteading. The current system is based on the erroneous assumption that new capital formation can only be financed out of existing accumulations of savings, which limits the financing for economic growth to what has been reserved out of past consumption — the Malthusian idea of no growth. The "slavery of past savings" also means that people believe that cutting consumption by inflating the currency and raising the price level, redistributing just enough wealth through the tax system to keep things going, and piling up retained earnings instead of paying them out to owners is the only way to finance growth. Ironically, this undermines one of the most important rights of private property: the right to enjoy the fruits of ownership. As William Cobbett, the "Apostle of Distributism" explained,

Freedom is not an empty sound; it is not an abstract idea; it is not a thing that nobody can feel. It means, — and it means nothing else, — the full and quiet enjoyment of your own property. If you have not this, if this be not well secured to you, you may call yourself what you will, but you are a slave. (A History of the Protestant Reformation in England and Ireland, 1827, §456.)

Consistent with Say's Law of Markets and the real bills doctrine, however, once we are freed from the slavery of past savings, there is no artificial limit imposed on growth in the form of reliance on the fallacious "supply of loanable funds." There is as much economic growth as is necessary to supply people with their wants and needs, no more, no less.


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