The closer we get to Halloween, the more obvious it becomes that something is seriously wrong with the global economy — as if the past three years haven't given us a less than subtle hint. The "Occupy Wall Street" movement has, as is inevitable, exploded into violence as frustration grows as a result of expectations based on false assumptions. The State has been presented as the only savior — as one enthusiast put it, "the sole intercessor available to the poor" — and the private sector ("the corporations") as incorrigible villains beyond all hope of redemption that must be destroyed, humbled, or brought under State control so the government can run things properly.
Can, however, the State do a better job of running the economy than the private sector? As we have seen in the previous posting in this series, the State hasn't done such a great job of creating money in a way that stimulates wealth production and sustainable job creation. This suggests that the private sector — if allowed to operate in accordance with sound principles of justice and common sense — might be able to do better.
In contrast to State-issued or sanctioned money backed by the present value of future tax collections (that may or may not actually be collected), private sector money in the form of bills of exchange (which take a seemingly infinite number of forms) is backed by the present value of existing and future marketable goods and services owned by the issuer. Technically, a bill of exchange backed by existing marketable goods and services is called a "mortgage." A bill of exchange backed by the general creditworthiness of the issuer — that is, the future marketable goods and services the issuer expects to produce or obtain — is (somewhat confusingly) also called a bill of exchange.
We've heard a lot of talk about "derivatives" in recent years. "Derivative" is simply the modern term for a bill. All money is derived from the present value of existing and future marketable goods and services, and can take any form to which the contracting parties agree.
In the Just Third Way analysis, we've found that the old distinction between "real bills" and "fictitious bills" much more useful than the new term "derivative." As Henry Thornton, the "Father of Central Banking," pointed out in his Enquiry into the Nature and Effects of the Paper Credit of Great Britain (1802), anything with a present value can back a "real bill," so-called because it represents real value. The backing of a fictitious bill, on the other hand, either doesn't exist (the instrument is fraudulent), or has an uncertain or indiscernible present value.
Applying Thornton's analytical framework to the recent housing bubble, the bursting of which triggered the current "recession," we see that massive amounts of private sector money were issued — "bills drawn" (derivatives created) — backed by "dodgy" mortgages, paradoxically backed by government guarantees . . . private sector money presumably backed by the present value of existing marketable goods and services, but in reality by the present value of future tax collections that the electorate had not granted. The massive amounts of "mortgage backed securities" were thus, in fact, not "real bills at all," but "fictitious bills" — fraudulent instruments issued by the private sector but effectively sanctioned by the government!
It is no wonder, then, that the whole thing caved in. Nor is it any wonder that we can't seem to get out of the pit by applying as a remedy the same thing that got us into trouble in the first place. As Lawrence Summers declared in his column in today's Washington Post, "The central irony of a financial crisis is that while it is caused by too much confidence, borrowing and lending, and spending, it can be resolved only with more confidence, borrowing and lending and spending." That's like saying that pain in your head that was caused by hitting yourself repeatedly with a hammer can only be solved by continuing to hit yourself on the head with a hammer . . . only harder. (That's the "horror" part of today's posting.)
With that kind of thinking, it's no wonder nothing seems to work. Avoiding the whole issue of good uses of credit as opposed to bad uses of credit makes it sound as if spending alone is going to get us out of the hole. That's one-third right. Spending on new capital formation — production — using pure credit financing and limiting all consumption spending (including government and Wall Street speculation) to existing savings is the only way to reverse a century or more of using pure credit financing on consumption. Making certain that all the new capital financed in this way is broadly owned so that the income is used first to pay for capital acquisition and then consumption will keep the economy running at full speed without bailouts or government-induced inflation.