Monday, March 26, 2012

The Situation in Greece

Since the last solution, people's attention has shifted away from Greece. This does not, however, mean that things are any better. It just means that the powers-that-be aren't thinking about Greece as the rest of the world implodes economically and the nations of the world try to get out of debt by spending more money. As soon as the next riot breaks out or Greece can't pay the refinanced debt, the media will be full of baffled confusion and amazed consternation that the latest fix didn't work.

Thoughtful ordinary people, however, are still wondering how it is possible to spend your way out of debt. As one Faithful Reader asked last week, "Where does the money that is initially loaned come from? Is it truly the result of capital accumulation? Or is it somehow an accounting trick, an entry in a ledger?

"In other words, are the Greeks being asked to pay back funds which were truly loaned to it from the accumulated capital of other nations and workers, or, is it being asked to pay back funds that were created out of nothing by banking institutions that will be able to create similar amounts again even if Greece defaults? Or is my question a silly one?"

The question is not a silly one. Understanding the Greek (and the U.S.) situation, however, requires a better definition of money than the powers-that-be are using, and a better understanding of banking, both deposit banking and issue banking. Currently, following the "currency school" of finance, "money" is construed almost exclusively as coin, banknotes, demand deposits (checking accounts) and some time deposits (savings accounts), and defined by its function, i.e., medium of exchange, store of value, etc., that is, by whatever is accepted as money does or can be made to do. The legal and accounting definition of money — "anything that can be accepted in settlement of a debt" — is disregarded or ignored.

Viewing money, as Keynes put it, as "a peculiar creation of the State," allows governments to create money at will by emitting bills of credit, and force its acceptance on the economy by fiat (hence "fiat money"). Keynes, however, failed to realize that money is not limited to State-emitted bills of credit, whether in the form of token coinage, banknotes or demand deposits, nor does the mere issuance of a currency or creation of a demand deposit "create money." Money is not created by issuing an instrument, but by accepting it.

This is consistent with the "banking school" understanding money as a promise. All money is a contract, just as (in a sense) all contracts are money. A contract consists, in relevant part, of an offer, an acceptance, and consideration. A government can make offers — issue currency or create demand deposits — and force the public to accept it as money, but the State cannot thereby give consideration (something of value that induces someone to enter into or "accept" a contract), for the State as a State produces nothing in the way of marketable goods and services. The State can only redeem its bills if the citizens grant it taxes and actually pay the taxes.

Further, people cannot pay taxes unless they have something to pay them with, and they will only have the wherewithal if they can produce marketable goods and services with their labor or capital, preferably both. The State's ability to make good on its fiat money is therefore backed only by the present value of future tax collections. If nothing is produced, or if the State isn't granted taxes or lacks the power to collect the taxes, the currency becomes worthless, and no one will accept it.

This is what has been happening in Greece. The government has been spending the present value of future tax collections like a drunken sailor on leave, and, at the same time, discouraging investment in productive activity with a vengeance. It has been bailed out by having other countries pledge the present value of their future tax collections to pay for Greece's past expenditures in the ephemeral hope that Greece will, contrary to its recent history, actually start producing marketable goods and services, the income from which can be taxed and used to redeem the promises that have been made so lavishly.

There is no accounting trick involved, only a serious conceptual problem about where money comes from and how it is created. Greece got into trouble by funding social programs with bills of credit, also known as "anticipation notes" from the fact that they are floated in anticipation of being able to collect taxes in the future to redeem the promises. If an economy is strong and the government secure, a country can get away with this for quite some time, but there must be a growing economy in which the bulk of citizens participate, or the tax base will erode to the point where the State simply cannot collect enough in taxes to pay for its past expenditures. At that point, it either has to devalue its currency (steal from current holders of its obligations) get bailed out (effectively surrender its sovereignty), or declare bankruptcy and refuse to honor all obligations.

Greece has not been loaned existing financial capital, that is, instruments representing the present value of existing marketable goods and services. Instead, it has been loaned the present value of future tax collections of other countries. This gives the illusion that money can be created out of thin air, but that is deceptive. What it's really being created out of is people's faith in the ability of the issuer of the loans to obtain repayment from the borrower, or pick up the tab by expending their own future taxes. Where the borrower — Greece — is going to obtain the funds for repayment is anybody's guess at this point, since the economy is in a shambles. Until, however, people realize that there will probably be no repayment under the current system, and that the countries who backed up the loans with their own faith and credit probably will be very reluctant to guarantee more loans, everything will be fine. When they do realize that Greece probably won't be able to repay as things now stand, the collapse will come.

There is, however, hope. After the Franco-Prussian War, an indemnity was imposed on France that was specifically intended to destroy France economically. By taking advantage of Pasteur's discoveries and the surge in demand for French products, and producing their heads off, however, France repaid the indemnity in less than three years. In some respects, France entered a "golden age" in the latter quarter of the 19th century, thanks in large measure to the rapid expansion of productive capacity and new markets (and the flood of silver on the world market that depressed the price, Bismarck having unwisely agreed to accept silver French Five Franc pieces in payment as well as gold).

Greece could do something similar by reforming its monetary and tax systems, and aggressively promoting a program of expanded capital ownership, financed not with the present value of other countries' tax collections, but by monetizing the present value of future marketable goods and services to be produced in Greece by discounting and rediscounting private sector bills of exchange, not public sector bills of credit. This would increase both production and effective demand, and at the same time rebuild the tax base and lessen the pressure on social welfare expenditures by helping people help themselves, not remaining what Heinrich Rommen called "passive State serfs" and "insolent bureaucrats," trapped by their dependency on the State for their subsistence.

Further, there is no need in the short- to mid-term to rely on increased exports. As Harold Moulton pointed out decades ago, there is enough unrealized demand present in all economies to absorb virtually all new production in the foreseeable future — if, as Kelso and Adler added, ownership of the new capital instruments financed with future increases in production instead of past reductions in consumption is spread out among people who will use the income first to pay for the capital that generated the income, then for consumption instead of reinvestment.

The injustice of the current system is in the maintenance of barriers that inhibit or prevent full participation of everyone in the economy through ownership of both labor and capital. Justice can be restored by acts of social justice directed at reform of our institutions — in this case tax and monetary policies that have concentrated ownership or control in the hands of a private elite or State bureaucracy (Pius XI's "dictators of money") — and in establishing and maintaining the "four pillars of an economically just society":

1. A limited economic role for the State. As Leo XIII observed, "There is no need to bring in the State. Man precedes the State, and possesses, prior to the formation of any State, the right of providing for the substance of his body." (Rerum Novarum, § 7.) The State must be confined to regulation, not ownership or control.

2. Free and open markets within an understandable and fair system of laws as the best means of determining just wages, just prices, and just profits.

3. Restoration of the rights of private property, especially in corporate equity and other forms of business enterprise.

4. Widespread direct ownership of capital, individually or in free association with others.

Adding the three principles of economic justice (Participation, Distribution and Harmony), would mean a quantum leap in how we address the situation in Greece — and in other countries.

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