Tuesday, November 15, 2011

It's Academics v. the Politicians . . . v. Economic Reality, Part IV: Economic Taxonomy 101

The problem with discussing today's economic problems (at least in part) is the fact that when the subject is money and credit, a lot of the terminology is pretty old, and yet the terminology in economics is relatively new, mostly rooted in Keynes's "re-editing of the dictionary" in an effort to force his unworkable system at least to sound plausible.

That's not to say that Keynes and the Keynesians, neo and otherwise, don't believe absolutely in their assumptions and the system(s) based on those assumptions. The problem is that the assumptions, especially about money and credit, are just plain wrong.

Be that as it may, we have to give a mercifully brief, and unmercifully short (and thus possibly misleading) glossary of some financial terms that today's economists and politicians either reject or redefine, thereby distorting their understanding of economic reality. This is actually pretty simple.

What are those things? A "mortgage" is something handing over ownership of something that exists right now.

A "bill of exchange" is something handing over ownership of something that the hander-over doesn't have right now, but expects to have when whoever has the bill presents it on the due date.

A "bill of credit" is something handing over ownership of future tax collections by the government.

A bill of credit is unique in that it hands over ownership of taxes that the government won't own unless the taxpayers both allow the government to tax, and the government is actually able to collect the taxes. Someone who issues a bill of exchange has to produce a marketable good or service or the value thereof to redeem his or her promise. A government that issues a bill of credit relies on somebody else producing marketable goods and services that can be taxed.

As you can see, this is pretty straightforward, but it does let you in on a Big Secret: Government does not create money by issuing bills of credit. No, the commercial banks and the Federal Reserve create money by accepting bills of credit.

Here's another Big Secret: private sector bills of exchange, being asset-backed, are better money than government bills of credit, which are debt-backed. The Federal Reserve, in fact, was invented to create money backed by private sector bills of exchange, not government bills of credit.

The primary business of the Federal Reserve was supposed to be creating an "elastic currency" by rediscounting bills originally discounted by its member banks, thereby backing the currency with private sector hard assets. "Open market operations" were only supposed to supplement rediscounting, and even then be limited to bills and notes issued by private sector businesses, individuals, and non-member banks. The government wasn't supposed to be able to sell its debt to the central bank — and a good argument can be made that it isn't supposed to create money in any way, shape, or form.

Anyway, we should be focusing on returning the Federal Reserve to its original mission of financing private sector development, not government operations. Let the government live off tax revenues, the way the Founding Fathers intended, thereby giving taxpayers a little control over the politicians.


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