Thursday, March 24, 2011

The Worst Disaster Since World War II, Part IV: Financing the Future

According to an Associated Press, the Japanese government expects that "the cost of the earthquake and tsunami that devastated the northeast could reach $309 billion, making it the world's most expensive natural disaster on record." ("Japan Disaster Likely to be World's Costliest," AP, 03/23/11.) Nor will the effects be confined to Japan. As one Japanese economist stated, "The aftermath of the tragic events in Japan will obviously alter the domestic economy. However, Japan's position in the global economy is such that there must also be some transmission of the shock to other parts of the world."

This suggests a rather grim, if not bleak future. As one Japanese journalist remarked in a personal communication to this writer, "Though Japanese stocks rallied sharply recently, many Japanese economists are pessimistic about the economy. There was a huge loss in productive capacity in many industries, especially automakers like Toyota that is expected to decrease production due to planned power outages as well as the quake. . . . Is there any hope for Japan?"

The answer? Yes — but not if financing the future Japan is carried out in the usual, that is, Keynesian way, and relies on existing accumulations of savings to fund the effort through taxation and inflation. The previous three postings in this series have given a relatively optimistic picture of the capacity of the Japanese people not only to rebuild, but to attain once again their former status as the second largest economy in the world. Implementing a program of "Capital Homesteading" — whatever they might want to call it — and building participatory ownership of the "new" economy into the people of Japan through financing vehicles such as Capital Homestead Accounts, Citizens Land Banks, and Homeowners Equity Corporations offers a great deal of hope to Japan, but only if the money can be found to finance the effort . . . and $309 billion is a lot of money.

Yes, $309 billion is an enormous sum, and, assuming traditional, past savings-based financing, could impoverish or cripple Japan economically for decades. Fortunately, there is a viable alternative to past savings-based financing available. This is an alternative that will not have a negative impact on either the Japanese or global economy, and can make everyone in Japan (at least in relative terms) rich in the process — and without taking anything from anyone else.

Pure Credit v. Past Savings

As regular readers of this blog are already doubtless aware, we refer to the "pure credit" principles of the "Banking School of finance" under "Say's Law of Markets" and the "real bills doctrine" as analyzed by Dr. Harold G. Moulton in The Formation of Capital (1935). Louis O. Kelso and Mortimer J. Adler refined Moulton's ideas by adding the essential expanded ownership factor in The Capitalist Manifesto (1958) and The New Capitalists (1961). The Center for Economic and Social Justice ("CESJ") applied the integrated package in a comprehensive Just Third Way economic reform proposal called "Capital Homesteading" in Capital Homesteading for Every Citizen (2004).

The significance of the Just Third Way as the optimal framework within which to rebuild Japan is found in the subtitle to The New Capitalists: "A Proposal to Free Economic Growth from the Slavery of [Past] Savings." Without the "pure credit" financing described in The Formation of Capital, funds for rebuilding will be limited to existing accumulations of savings (which are already invested), or future reductions in consumption.

Unfortunately, liquidating existing investment to finance rebuilding would further decrease existing productive capacity. Reducing existing productive capacity would decrease supply and thus profitability, making the whole exercise pointless. Cutting current or future consumption to finance new capital formation — restricting demand — would also seriously compromise the profitability of the new capital, making the new capital less feasible financially and, again, rather pointless.

The answer? Get out of the "past savings box." There is absolutely no reason for economic growth and development to be tied in any way, shape, or form to existing accumulations of savings except, possibly, to serve as collateral for loans extended to finance new capital — and collateral can be replaced by capital credit insurance and reinsurance.

Financing the Future

The key to getting us out of the "past savings box" is to realize that there is an invention specifically designed to allow people to finance new capital without the use of existing accumulations of savings or by restricting current or future consumption. This is the "commercial (or mercantile) bank," backed up with a "central bank."

The process sounds complicated, especially when contrasted with the simplistic belief that new capital can only be financed by cutting consumption and accumulating money savings. To try and make it as simple as possible, however, the process of financing new capital without first cutting consumption works something like this:

Someone has a "financially feasible" project in mind. That is, someone has the opportunity to purchase or build capital that will generate a profit by producing marketable goods or services. This opportunity has a "present value." If the cost of purchasing or building the capital is less than or equal to the conservatively estimated present value of the stream of profits to be generated in the future, the capital is a "good buy" and worth financing.

The owner of the present value of the capital (which doesn't yet exist except as a business plan) "draws a bill" on that present value. This is a "bill of exchange," and consists of a contract to redeem the bill at some specified date in the future, or on the occurrence of some specific event. This bill can either itself be used as money and used to purchase or build the capital, or taken to a commercial bank and exchanged for a promissory note issued by the bank, and the bank's promissory notes used as money.

In both cases the transaction is called "discounting." If the bill passes to another "holder in due course," it is called "rediscounting." To spread the risk and ensure a uniform currency, the bank can rediscount the bill at a central bank, which issues its own promissory note to the bank. The "borrower," that is, the original drawer of the bill, purchases or builds new capital, makes it profitable, and redeems (buys back) the bill from the bank, and afterwards uses the income from the capital — the profits — for consumption. Both supply (production) and demand (consumption) have been increased without reducing either production or consumption. On the contrary, both production and consumption have been increased.

If everyone in an economy finances new capital in this way, production and consumption will be equal. The economy will be in balance and prosperous. This is why Kelso and Adler insisted that all new capital financed using the real bills doctrine (an application of Say's Law of Markets) must be broadly owned by as many people as possible. This would ensure that people would have to save only for emergencies, not to finance new capital, thus keeping demand high naturally, without the need for artificial stimulus by government.

The hardest part of this program is to realize that the financing of new capital formation need not be tied to the "supply of loanable funds" — the existing accumulations of savings — and that the currently wealthy do not have to give up anything. The non-rich can finance and thus own new capital without cutting consumption, or borrowing or redistributing the savings of the rich.

In this way Japan can "finance the future" without harming their economy further, and — as they did when they adopted "the Demming Way" — show the way to the rest of the world, coming out on top in the process.

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