Thursday, February 17, 2011

The "Two-Tiered" Interest Rate, Part III: Some Effects

Some people, especially those on fixed incomes with a significant proportion of their assets (such as they are) invested in, e.g., government bonds, are quite properly worried about their security of income once Capital Homesteading is in place. This is a serious issue, and one that deserves a serious response.

Thus, when we say, "not to worry," we mean just that. True, most retired people would not realize as much as others from Capital Homesteading if it were enacted tomorrow. The benefits don't really start accumulating until you've been purchasing capital for a couple of decades or so. Capital Homesteading does not promote reinvestment of earnings (or, at least, discourages it), so that the "magic of compound interest," or earnings on earnings, does not operate. Consistent with Say's Law of Markets, income is meant to be consumed or used to retire acquisition debt, not accumulated to finance new capital.

There are, however, features of the monetary and fiscal reforms in Capital Homesteading that will greatly benefit those who have cut consumption and saved in the past, even if not in the future. First, of course, there will be a significant tax deferral on current income if existing investments are deposited in a Capital Homestead Account. A retired person might not be able to accumulate $1 million by taking his or her annual capital credit allocation, but could receive the same tax benefits on existing accumulations. And remember — the personal exemption under Capital Homesteading would be raised to an estimated $30,000 per non-dependent. Conceivably, many retired people living on modest incomes might not pay taxes for the rest of their lives.

But what about the fiscal reform that would prohibit the monetization of government deficits, and the proposal to repay the entire outstanding government debt within a generation?

Again, this is nothing to worry about. First, of course, when the government monetizes its deficits by issuing bonds that are purchased on the open market by the Federal Reserve, the currency is inflated, and the purchasing power of anyone on a fixed income is reduced, often even if the number of dollars he or she receives is increased. Wage earners and people on fixed incomes are always hurt to some degree by government deficits. The only people who benefit are owners of capital, who receive higher prices for fewer goods and services — a process Keynes called "forced savings," and relied upon to provide financing so that the rich can acquire even more capital at the expense of the poor.

What about when the government is unable to create money at will and set the interest rate? First, many people are unaware that Federal Reserve profits are not distributed to the nominal owners of the Federal Reserve — the member banks. Instead, profits are turned over to the U.S. Treasury. Effectively, the government pays a small service fee, sometimes not even that if the member banks have paid for services. The government can actually make a profit on Federal Reserve operations, and receive all of its funding for "free." The interest rate on government bonds sold to the Federal Reserve is irrelevant.

Second, under the two-tiered interest rate, the government will not only not be able to borrow from the Federal Reserve any more, whether directly or indirectly, but will have to go to existing accumulations of savings to borrow. Naturally, in accordance with the laws of supply and demand, this will drive the market rate of interest on existing savings very high — the government is a borrowing addict, and will not be able to stop cold turkey. That means that retirees and others invested in government bonds will see their incomes rise significantly as the government is forced to pay actual market-determined rates of interest on what it borrows in competition with all the other borrowers, including consumers, who will be cut off from money creation for anything other than financing new productive capital.

The foundation of this new system is found in Dr. Harold G. Moulton's The Formation of Capital (1935). The idea is that existing accumulations of savings are not a financially feasible source of financing for non-speculative capital investment, but should be used for consumption, including government spending and speculation. All financing for new capital that meets eligibility requirements (including widespread ownership) should be financed using the "pure credit" methods described in The Formation of Capital, and refined by Louis Kelso and Mortimer Adler in The New Capitalists (1961).

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