Tuesday, August 25, 2015

Flexible Standards, VIII: An Elastic, Asset-Backed Currency

Here’s the secret to keeping calm amidst all the panic on Wall Street yesterday.  All you have to do is keep on thing in mind: like the preacher’s watch on the pulpit during the sermon, “It don’t mean a damn’ thing.”

Nothing new under the sun ... the Panic of 1873.
That’s right.  Wall Street is a “secondary market.”  That means it’s a secondhand shop for used corporate debt and equity.  For example, do you know how much money a company gets when its shares go from $10 to $1,000 on the market and it has 1,000,000 shares outstanding?

Nothing.  Zip.  Zero.  The company doesn’t get one cent of an increase in the price of its publicly traded shares.  The company got its money when the issue was floated, and not one cent after that.

Frankly, even if your entire fortune is in equity and debt, you didn’t lose or make one single cent yesterday . . . unless you bought or sold.  It’s all on paper.  A gain or a loss means absolutely nothing until and unless you “liquidate,” i.e., sell it.

Well, bust my buttons, a horse of a different color. . .
That being said, however, what do we do to fix it?  That’s a horse of a different color. . . .

One of the most fundamental principles in Keynesian economics, if not the most fundamental, is the idea that there are no fundamental principles.  Obviously this is contradictory, but no more so than the pundit who proclaims that there are absolutely no absolutes.

We hate to repeat ourselves, but it is necessary at this point to quote what has to be the most damaging passage in all the writings of John Maynard Keynes.  It’s from the opening pages of the work intended to be his magnum opus, The Treatise on Money (1930).  As Keynes declared,

"Now, children, Unca' Keynes will read his financial fantasy..."
 “It is a peculiar characteristic of money contracts that it is the State or Community not only which enforces delivery, but also which decides what it is that must be delivered as a lawful or customary discharge of a contract which has been concluded in terms of the money-of-account.  The State, therefore, comes in first of all as the authority of law which enforces the payment of the thing which corresponds to the name or description in the contract.  But it comes in doubly when, in addition, it claims the right to determine and declare what thing corresponds to the name, and to vary its declaration from time to time — when, that is to say, it claims the right to re-edit the dictionary.  This right is claimed by all modern States and has been so claimed for some four thousand years at least. It is when this stage in the evolution of money has been reached that Knapp’s Chartalism — the doctrine that money is peculiarly a creation of the State — is fully realized.”

To put this in simple English, according to Keynes, the State has the right to change the value of the currency, the value of the standard of the currency, and even the standard itself at will.  The bottom line is that Keynesian economics is built on a solid foundation of the assumption that there is no such thing as a foundation, solid or otherwise.  The State tells you what something is, and that’s what it is until the State tells you otherwise.

The logical end of Keynesian economics.
The Keynesian system is thus productive of total chaos, into which society dissolves whenever people realize that there are no absolutes — no standards — and that nothing has any meaning except what someone with a bigger club than you have insists is the case . . . until it isn’t.  Fortunately, however, restoring sanity (and standards) is relatively simple, although far from easy, given the political, financial, and academic inertia prevalent these days.  The following steps will institute an elastic, asset-backed reserve currency for the United States beginning immediately, eventually retiring all currency backed by government debt (“elastic” means the currency expands and contracts with the needs of the economy without inflation or deflation):

Step One: Immediately define the reserve currency in terms of a fixed and uniform standard.  We recommend that the U.S. Dollar be defined as having the value of ten Standard Kilowatt Hours, meaning the value of a Kilowatt Hour delivered.  Congress has the power to do this under Article I, § 8 of the Constitution.  This will “fix” the price of a Kilowatt Hour and thus the value of a dollar within a narrow range, but energy is regulated anyway, and this doesn’t really change anything there.  Obviously, based on the local market, the actual delivered price of a Kilowatt Hour will vary from the standard, but not very much.  When gold was the standard in the late 19th and early 20th century the local price of gold, especially in local markets, often varied from the $20.63 official price, although not by much.  We described this in Flexible Standards, IV: Selecting a Standard.

Rep. Carter Glass, Lynchburg, VA.
Step Two:  Immediately reinstitute Glass-Steagall, except with much stronger provisions.  Within 90 days there must be a complete separation between investment banking, commercial banking, insurance, and all other discrete forms of banking and financial services.  Commercial banks may temporarily continue to offer consumer banking services, but these must be phased out or spun off from the commercial banking function within three to five years.  Credit unions, savings and loans, and similar institutions were designed to handle consumer banking services, and specialization in financial services is one of the keys to good internal control.

Step Three: Immediately open the Federal Reserve Discount Window to rediscount “qualified agricultural, commercial, and industrial paper” from commercial banks.  This, again, is what the Federal Reserve was designed to do.  Make certain, however, that “qualified” is defined as including a provision that expands ownership of newly formed capital, and is limited to financially feasible capital projects adequately collateralized, and “acceptable collateral” is defined as capital credit insurance.  Extend the term of qualified paper to up to ten or fifteen years, as was done in part in the 1930s in an effort to provide funding for new capital (it didn’t work very well because otherwise qualified borrowers lacked collateral in the form of capital credit insurance to be able to take advantage of the program).  Short-term paper (90 day or less) may qualify without the expanded capital ownership provision, unless renewed past 360 days.  (This will institute 100% reserves for all loans rediscounted at the Federal Reserve.)  All of this is either currently in the law, or could be added without legislation with regulations.  Also, begin phasing out open market operations in government debt paper, with the goal of retiring the debt completely and backing the money supply 100% with private sector assets.

A more just tax system...couldn't be worse than what we have.
Step Four: Reform the tax code, simplifying it by treating all personal income from whatever source exactly the same for tax purposes.  Exempt from taxation $20,000 for dependents, $30,000 for non-dependents, eliminate all other deductions and credits at the personal level, and give a lifetime deferral of $1 million on the current value of capital in a Capital Homestead Account.  Tax all personal income above the exemption and deferral at the same rate for everybody.  Increase the corporate tax, but make dividends tax deductible at the corporate level, and treated as regular income at the personal level, unless used to acquire dividend-paying assets in a Capital Homestead account.  A corporation or other business that pays out all profits and finances growth with new equity issues would thereby avoid all corporate income taxes.

Step Five: Enact a Capital Homestead Act that enables every child, woman, and man to borrow newly created money to purchase a pro rata share of the capital “growth ring” added to the economy each year, to be repaid with future dividends received on the shares purchased.

This, in bare outline, is the way to establish and maintain a fixed and uniform standard for the reserve currency — the currency into which all other forms of money can be converted, and which thereby serves as the standard of value.  The world economy has for too long been shackled by governments and politicians that manipulate the value of the currency to achieve political ends — which is why the United States has more than $18 trillion in government debt, Greece is bankrupt, and the global market is in a turmoil.

And yet it can be fixed very easily.


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