So far in this
discussion we have discovered that the distributist economist we’ve been
calling “Tom Steele,” and his associate we’ve termed “Joe Wide,” have made
three fundamental errors in their financial analysis. These are, 1) the belief that future cash
flows can be known with absolute certainty in the present, 2) that there is an
ideal value or price of something that has no relation to the value that buyers
and sellers assign to what is being exchanged, and 3) Return On Investment
(ROI), the discount rate, and the interest rate are all the same. We can now address what may be the most
fundamental error of all: their understanding of money and credit.
Error Number Four
 |
| Louis O. Kelso |
The entire
discussion up to this point has assumed that the capital has been purchased
using existing savings loaned by a saver.
That is, we have been using the assumption that the only way to finance
anything is to cut consumption and accumulate money savings. Is that, however, how the system should work?
No. As Dr. Harold G. Moulton proved in his
classic refutation of Keynesian monetary theory, The Formation of Capital (1935),
financing for capital expansion should not come out of past savings (past
reductions in consumption), but out of capital credit repaid out of “future savings” (future increases in
production). The “pure credit” system
Louis Kelso and Mortimer Adler described in their second book, The New Capitalists (1961) — based on Moulton’s work —
eliminates the need to use past savings as the source of loans to universalize
access to capital ownership and incomes not dependent on government
redistribution and jobs.
This is why the
subtitle of The New Capitalists is,
“A Proposal to Free Economic Growth from the Slavery of Savings.” Pure credit allows any financially feasible
capital project to be financed by increases in production in the future,
instead of being limited in what can be financed by being restricted to savings
that were withheld from consumption in the past.
To understand
this, we have to know what financial historian Benjamin Anderson called “the
first principle of finance.” And that
is? To know the difference between a
mortgage (a financial instrument based on existing assets) and a bill of
exchange (a financial instrument based on future assets).
We have already hinted
at the difference in the discussion of discounted cash flow. Existing savings loans bear interest. Future savings loans are discounted. In discounting,
the lender covers costs, the risk premium, and is compensated for his services
out of the discount, the difference between the amount of money created for
investment, and the amount of money repaid, covering the original loan
principal plus the discount.
There is another
difference. Existing savings loans bear
interest as long as any part of the principal is outstanding. Future savings loans are only discounted once
by the original lender; any subsequent (re)discount is a new transaction
between different parties.
For example, a
borrower obtains a ten-year loan of $1 million of existing money (past savings
money) bearing a 10% annual straight interest rate with a single balloon
payment at term. He will pay the lender
$1 million in principal back, and $1 million in interest, out of future
profits, for a total of $2 million.
In contrast, a
borrower who obtains a ten-year loan of $1 million of newly created money (future
savings money) discounted at 10% receives $900,000 and pays back the original
$900,000 plus $100,000, all out of future profits, to bring the amount up to
the face value of the loan, a total of $1 million.
The key to
understanding the difference in the two loans that sound otherwise identical is
to realize that the borrower of past savings borrowed someone else’s existing,
old money, and paid $1 million for the privilege, while the borrower of future
savings actually participated in creating
new money, and paid $100,000 for the privilege — a $900,000 savings.
That is for loans
to conventional businesses. While the
annual interest or one-time discount on a standard business loan is tax
deductible, principal payments are not.
In an ESOP, however, both principal and interest are tax deductible; the
entire loan is repaid with “pre-tax dollars.”
Even that is only
for a “C-Corp ESOP.” An S-Corp that is
100% owned by the workers through an ESOP pays no corporate income taxes at all
under current law, so taxes are not an issue.
At current state and federal corporate tax rates, that can add as much
as 50% or more to the bottom line, accelerating repayment of the acquisition
loan and making more cash available sooner for profit distributions to the
workers.
Conclusion
Wide and Steele are
trapped by their assumptions regarding money and credit, savings, and
definitions of terms. They ignore
economic and financial reality and try to force the question into an ideal world
that not only does not exist, it cannot even be conceived except by allowing
contradictions — which violates the first principle of reason. In this way they set up a very flimsy straw man
argument for leveraged ESOPs that they have no trouble demolishing to make
their case, but which only succeeds in baffling anyone who lives and works in
the real world.
The real problem,
however, is that by focusing on a peripheral issue — the feasibility of the
ESOP (and misunderstanding even that) — Wide and Steele avoid addressing the
need to develop and implement a fiscally sound and morally consistent way to
resolve the growing wealth and income gap.
By obsessing over the presumed flaws or inadequacies of a single tool,
the ESOP, they ignore the importance of the principles behind the ESOP that
have the potential to solve the problem of global poverty.
This appears to
be rooted in fundamental misunderstandings regarding private property, money
and credit, banking and finance, the role of the State, but above all social
justice and the principles of economic justice: 1) Participative Justice, 2)
Distributive Justice, and 3) Social Justice.
Misunderstanding social tools and the principles that should guide and
direct their use, Wide and Steele waste their time on trivialities, accusations
against “banksters” and other alleged villains, and vague philosophical
ramblings rather than on programs based on sound and tested principles.
 |
| Understanding money, credit, banking, and finance is essential. |
Specifically, Wide
and Steele need to understand:
·
Private
property — the inherent and inviolable right of every human being to be an
owner, and the socially determined and limited bundle of rights that define the
use of what is owned.
·
Money and
credit — anything that can be used to settle a debt; “all things
transferred in commerce.”
·
Banking
— the business of taking deposits, making loans, discounting notes, issuing
notes, collecting money on notes deposited, negotiating notes, and so on.
·
Finance
— the handling of money resources.
·
The State
— a social tool instituted by delegated authority of the people to establish
justice, keep order,
provide for common defense, promote general welfare, and secure and
protect fundamental human rights, particularly life and liberty, together with
the means of acquiring and possessing private property, especially productive
wealth (capital) by removing barriers that inhibit or prevent the use of just
and practical means to achieve equality of access to the rights and incomes
derived from ownership of productive capital assets, including land and other
natural resources.
 |
| Basic principles of economic justice. |
In addition, Wide
and Steele need to internalize the three principles of economic justice that
guide the above institutions:
·
Participative
Justice — how one
makes “input” to the economic process in order to make a living. It requires
equal opportunity in gaining access to private property in productive assets as
well as equality of opportunity to engage in productive work. The principle of
participation does not guarantee equal results, but requires that every person
be guaranteed by society’s institutions the removal of unjust barriers so that
every person is empowered to make a productive contribution to the economy,
both through one’s labor (as a worker) and through one’s productive capital (as
an owner). Thus, this “equal opportunity” principle rejects monopolies, special
privileges, and other exclusionary social barriers to economic self-reliance.
·
Distributive
Justice — the
“output” or “out-take” rights of an economic system matched to each person’s
labor and productive capital inputs. Through the distributional features of
private property within a free, non-monopolistic, and open marketplace,
distributive justice becomes automatically linked to participative justice, and
incomes become linked to productive contributions. The principle of distributive justice
involves the sanctity of private property and contracts. It turns to the free
and open marketplace, not government, as the most objective and democratic
means for determining the just price, the just wage, and the just profit.
·
Social
Justice — the
“feedback and corrective” principle that detects distortions of the input
and/or out-take principles and guides the corrections needed to restore a just
and balanced economic order for all.
Unjust barriers to participation violate this principle by monopolies or
by some using their property to harm or exploit others. Social justice does not replace individual
justice or charity, but makes the exercise of individual justice and charity
possible. Strict adherence to the
precepts of the natural law and the principles of reason as understood within
the Aristotelian-Thomist framework characterizes true social justice.
These
institutions and principles when integrated as the Just Third Way and applied
in Capital
Homesteading offer a way to “universalize”
the principles underpinning the limited applicability of the ESOP and
extend the benefits of expanded capital ownership to every child, woman, and
man on Earth. Thus, by —
·
Securing the right to private property and
defining the rights of private property in ways that best meet the needs of
individuals, groups, and the common good as a whole,
·
Creating money in ways that create new capital
owners instead of concentrating ownership,
·
Using the banking system to finance private
sector growth instead of government,
·
Handling monetary resources in a manner
consistent with sound business and morals, and
·
Restricting the State to its proper role of keeping
order and maintaining a “level playing field” by removing unjust barriers to
participation,
the Just Third Way offers a better
alternative for the future of humanity than divisive and pointless attacks
based on misunderstandings and half-truths on the one hand, or the
monopolization of economic power on the other.
Common sense
would therefore suggest that CESJ is correct in this matter, not Wide and Steele.
#30#