Monday, June 23, 2014

Distributism, Neo-Distributism, and the Just Third Way, III: Financing Capital


Neo-distributists like to talk a lot about “banksters.”  This neologism, however (while a clever play on “gangster”), displays a great deal of ignorance on the part of neo-distributists concerning money, credit, finance, and (of course) banking.  It begins with the fact that few, if any, neo-distributists can even define the different types of banks properly.

Commercial banking and central banking (banks of issue) was designed to finance new capital without the use of past savings for anything except collateral or reserves.  A bank of issue is defined as a financial institution that takes deposits, makes loans, and (here is the difference between a bank of deposit and a bank of issue) issues promissory notes.

To finance new capital without redistribution, an individual or business with a financially feasible project (i.e., a project that is expected to pay for itself out of its own profits in the future within a reasonable period of time) would offer a contract called a bill of exchange to a commercial bank.

The bank would review the offer, and, if it met their standards and was properly collateralized with capital credit insurance or reinsurance, issue a promissory note to accept and “discount” the bill.

(Mortgages, being based on past savings, bear interest based on the accumulated savings behind the instrument.  Bills of exchange, being based on future savings, are discounted to reflect the present value of the face value of the bill to be redeemed in the future, and are “interest free.”)

The bank’s promissory note is used to back a new demand deposit (checking account).  The borrower draws on the demand deposit to finance (“form”) new capital.  When the new capital becomes productive (i.e., profitable), a portion of the profits is used to redeem the bill of exchange and cancel the promissory note.

A commercial bank can rediscount the bills it accepts at a central bank.  The central bank then issues its own promissory note to rediscount the bill and creates a demand deposit for the commercial bank, thereby increasing the reserves of the commercial bank.  In this way it is possible to have 100% reserves sufficient to cover all commercial loans, and eliminate fractional reserve banking.

By accepting (discounting or rediscounting) only private sector bills of exchange instead of government bills of credit (a special form of bill of exchange backed by the present value of future tax revenues instead of the present value of future production) — as the original Federal Reserve Act of 1913 specified — the banks, both commercial and central, can create a stable, asset-backed, “elastic” currency, avoiding both inflation and deflation, and finance broad-based capital ownership without redistribution.

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