Tuesday, April 15, 2014

Focus on the Fed, VI: Capital Homesteading, A Realistic Solution


As we saw in yesterday’s posting, many factors have combined to put propertyless workers (and everyone else without capital) into a very bad position.  The wealth and income gap continues to grow, while attempts to deal with it from within conventional frameworks only make the situation worse.

What is needed is something from outside the usual way of thinking, which questions conventional wisdom with solid theory and practice, instead of vague whispers about a conspiracy or two.  We believe that Capital Homesteading, a program that fits within the parameters of the Just Third Way, should do the trick.

Harold Glenn Moulton
CESJ’s Capital Homesteading proposal is an application of the principles of economic justice presented by Kelso and Adler, and the principles of finance presented by Dr. Harold G. Moulton in his book, The Formation of Capital (1935).

Under a Capital Homestead Act, every child, woman, and man would have the right to purchase an equitable, pro rata share of newly issued corporate equity representing the annual “growth ring” of new capital formation.  The proposal is detailed in the book Capital Homesteading for Every Citizen (2004).  Our concern here is how capital acquisition is to be financed by people without existing savings, and who cannot afford to reduce consumption in order to save.

As Kelso and Adler pointed out, the answer is to finance new capital formation using future savings instead of past savings.  In this way the monopoly of ownership of future new capital can be broken, and everyone have an equal opportunity to own new capital.

Medieval Money Making
It is important to note that Capital Homesteading relies on the fact that no new money is to be created until and unless there is a properly vetted future capital project with a present value.  It is not necessary, despite what conventional wisdom maintains, first to create and accumulate money before surfacing financially feasible new capital investment.

A commercial bank can turn the present value of the future stream of income to be generated by the new capital into money by accepting (discounting) a bill of exchange offered by the prospective purchaser of the newly issued shares, and issuing a promissory note that can be used to finance the new capital.  For added security, the commercial bank can immediately rediscount the accepted bill (“acceptance”) at the local regional Federal Reserve, thereby maintaining 100% asset-backed reserves for all loans.

This method of corporate finance links the increase in the money supply directly to the increase in productive capacity through private property in the capital being financed.  As the loan is repaid out of the future profits of the new capital, the money supply is decreased.  If this results in too little money in circulation to clear existing inventories, the inventories can be turned into money by issuing mortgages.  In this way not only is the base of capital ownership greatly expanded, but the money supply is asset-backed and linked directly to the present value of existing and future marketable goods and services in the economy, resulting in a stable and elastic asset-backed currency.

The Question of Collateral

Insure against capital loss, too.
Kelso and Adler noted that, everything else being equal, the “universal collateralization requirement” prevented many people from becoming owners of newly formed and financed capital.  The project could be sound, the economy in good shape, the commercial banks have the capacity to create money for new capital formation . . . but many borrowers lack existing wealth to offer as collateral.  Without that collateral, a bank would not be acting in the best interests of anyone to create money for new capital formation or anything else.  It is too risky.

Kelso and Adler, however, noted that there is an industry that deals with risk: the insurance industry.  That being the case, why not use the “risk premium” charged on all loans as an actual premium to purchase an insurance policy?

Replacing traditional forms of collateral with an insurance policy that pays off in the event of default would enable people who lack existing savings and other wealth to use as collateral to purchase newly formed capital on credit, thereby broadening the base of capital ownership in the economy.

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