Tuesday, March 24, 2015

How to Restore an Asset-Backed Reserve Currency


In recent postings we’ve seen what can happen when an economy shifts from a uniform and stable asset-backed reserve currency, to one that is worth what the government says (or hopes) it is worth, and changes the standard to meet political needs, for short-term expedience, or just for the heck of it.

Honest Abe was supposed to be more honest than they made him, and backed with assets, not debt.
That’s why one of the major monetary reforms proposed under Capital Homesteading is to shift the backing of the U.S. reserve currency, the official Federal Reserve Notes and commercial bank demand deposits at the Federal Reserve into which all other forms of money can be converted on demand, from government debt (bills of credit), to newly created private sector assets. This would restore one of the original purposes of the Federal Reserve. Reliance on the United States Notes (“Greenbacks”) of 1862-1971, the National Bank Notes of 1863-1913, and the Treasury Notes of 1890, all of which were backed with government debt and “inelastic” (i.e., the amount outstanding was fixed by law), had contributed to the Panics of 1873 and 1893.

Large industrial and commercial interests had been able to create asset-backed money at will by discounting and rediscounting mortgages and bills of exchange. Small businessmen, farmers, and wage earners had been limited to the inelastic, debt-backed legal tender currency. This caused consumption power to lag behind production power, causing Say’s Law not to function.

Why is such a reform necessary from the standpoint of economic growth and expanded capital ownership? As pointed out by Dr. Norman A. Bailey, former Special Assistant to President Reagan for International Economic Affairs:

Dr. Norman A. Bailey
“The huge disparities in the ownership of productive capital lead inexorably to derivative imbalances in the international sphere, which in turn result in serial over-indebtedness and misallocation of capital investment to areas where the return is often nil or negative or at best below that level which would enable countries involved to service their debt burden. The result of this is recurring debt/financial/economic crises that are both endemic and resistant to treatment. The measures taken to respond to these crises have often exacerbated the disparities which led to them in the first place, thus completing the vicious circle.” (Norman A. Bailey, Ph.D., “Central Bank Funding of Economic Growth and Economic Justice Through Expanded Capital Ownership.” Speech delivered at the 2002 Conference on Globalization, Capital Ownership Group, Washington, D.C., October 2002.)

Dr. Bailey explained the inherent weaknesses of a debt-backed currency:

[A] central bank can purchase any asset with the currency and credit it issues. Over the history of central banking, starting in the late seventeenth century, central banks have issued currency and credit on the basis of purchases of precious metals, other currencies, commercial paper (industrial, commercial, agricultural or export) and other asset. The fact that at present most central banks, including the Federal Reserve System in the United States, fund their currency and credit issues primarily through the purchase of government securities (their own or other governments’) is simply part of the vicious circle . . . the monetary system is based on the government debt, a logical absurdity made necessary by the requirements of the welfare state. The total bankruptcy of this system was amusingly demonstrated when at the end of 1999, terrified by the specter of hordes of depositors demanding their money at banks paralyzed by the (as it turned out non-existent) Y2K computer problem, the Federal Reserve greatly increased the money supply, and since it had run out of government obligations to buy it bought huge quantities of Fannie Mae and Freddie Mac paper instead. Perhaps a better metaphor for this operation than that of a vicious circle might be that of a dog chasing its own tail. (Ibid.)

To prevent the current monetization of government deficits, the U.S. Treasury Department under a Capital Homesteading policy would be forbidden from selling the government’s debt paper to the Federal Reserve. The Federal Reserve would be forbidden to deal in both primary and secondary government securities.

The need to manipulate reserve requirements of commercial banks, the justification for the current provision allowing the Federal Reserve to deal in secondary government securities, would be obviated by the implementation of a 100% reserve requirement and rediscounting of all eligible paper.

Henry Calvert Simons
This is similar to the Chicago Plan, proposed in the 1930s as a solution to the banking problems of the day, except that the Just Third Way version uses hard assets in the form of private sector bills of exchange drawn on the present value of existing and future marketable goods and services to back the reserve currency, rather than the government debt (“bills of credit”) Henry Simons proposed.

The Federal Reserve would be required to rediscount qualified bills of exchange accepted by local banks, issuing promissory notes to back new currency or demand deposits. This would create sufficient money and credit to meet the liquidity and broadened ownership needs of an expanding economy.

In this way, the money supply would respond automatically to the demands of a more democratic private sector. Such “Federal Reserve monetized” loans would be subject to appropriate feasibility standards administered by the banks before any new money was created, and limited only by the goal of maintaining a stable value for the dollar.

Capital Credit Insurance and Reinsurance are Key
Capital Homesteading also requires the promotion of the availability of private sector capital credit insurance. This insurance would serve as a substitute for traditional collateral to cover the risk of default on eligible Capital Homesteading loans. This would open up ownership opportunities by expanding share ownership among workers and other capital-deficient citizens. This would be similar to the role played by home mortgage insurance for broadening home ownership in America.

Capital Homesteading would create a more stable reserve currency than we have today. The Federal Reserve’s current ability to use its money-creating powers to support foreign currencies or to buy and sell primary or secondary Treasury securities would be terminated. This would force the government to borrow directly from savers in the open markets. This is possibly the most sensitive aspect of Capital Homesteading, and raises a number of questions as to how to deal with it.

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