Thanks to the current tsunami of chaos in the political, social, economic, and everything else realms, we haven’t garnered too many outraged comments or questions about how risky the Economic Democracy Act is for workers and others. Instead, what we’re getting are honest questions about how risk — which is always a factor to be considered — will be handled.
This week, we got three related questions about the proposed shift from a reserve currency backed with government debt to a reserve currency backed with private sector hard assets would be handled and how it would affect people. Fair enough, so here are our responses:
1. Will the investor (new owner) or project initiator bear the business risk of achieving the intended asset returns?
As is customary in business in a free market, the risk of achieving the intended asset returns will be borne by the project initiator. The investor (new owner) will be insulated in three ways.
One, the “corporate screen” which in most countries consists of limited liability of shareholders and management. This of course also applies to the project initiator, who in most circumstances cannot lose more than is invested in the project.
Of course, limited liability may not apply if there is any malfeasance or crime involved; in most countries, corporate limited liability does not protect anyone who knowingly does wrong. It may protect someone who does wrong unintentionally (misfeasance or human error) but cannot ethically or legally in most cases be used to get away with a crime.
Two, the investor (new owner) will collateralize (hypothecate) the loan to purchase the shares with a capital credit insurance or reinsurance policy. Capital credit insurance is available in a limited way today, but this proposal would make it the preferred collateral to protect the new investors and thus the commercial banks making the share acquisition loans from loss. There is, of course, a danger that banks will make knowingly bad loans in the hope of making a profit from the collateral, so we propose that the amount of insurance be limited to the amount loaned, i.e., the new money created. The bank would therefore not lose the amount loaned, but it would not make a profit, either and would have to meet the expenses associated with making a bad loan out of other revenue.
Three, the investor (new owner) can take out “portfolio insurance” to protect the value of his investments if a company does not make the anticipated level of profit or goes bankrupt, and the shares consequently lose most or all their value. A form of this is sometimes available to the project initiator by insuring against a rise in the prices of raw materials, crop insurance, and similar arrangements.
Ultimately, of course, nothing can eliminate risk, but it can be spread around and minimized in various ways through insurance.
2. How would you measure and incorporate economic growth generated by the new currency into the overall economic value?
This would be done by comparing the total new investment with the total investment under the program. For example, if there is $10 trillion of new investment in a period and $1 trillion of new investment financed the new way, a very crude estimate would be to take 10% of GDP as the amount of economic growth attributable to the new program.
A better, although more complex way, would be to compare the amount of economic growth due to enterprises, whether private or SOE, and the amount due to enterprises participating in the program.
A further refinement would be to determine on a per enterprises basis (which company management should be doing for their own purposes anyway) how much growth is due to the new investment financed in the new way.
Studies by the National Center for Employee Ownership in Oakland, California suggest that worker-owned enterprises that have profit-sharing and participatory management are 150% more profitable than otherwise comparable firms. This may or may not translate into similar results when ownership is spread throughout the entire economy, not just workers, but we believe the profitability of well-run companies with good products will be much more profitable if they are broadly owned by workers and citizens.
3. Introducing an asset-backed currency alongside the existing government debt-backed currency will create a two-tier economy. What challenges might arise, and how would you address them?
There should be no real challenge, as the asset-backed currency should be indistinguishable in appearance from the existing government debt-backed currency, and no one will be able to tell the difference between a debt-backed banknote and an asset-backed banknote.
In effect, each banknote and coin in circulation will be both debt-backed and asset-backed, because they would be all legally the same. For example, if 75% of the currency in circulation is backed by government debt and 25% is backed by private sector assets, then each banknote and coin is 75% debt-backed and 25% asset-backed. Of course, as government debt is repaid and more money is created backed by assets, the percentage of asset backing for each piece of currency will increase. If all government debt used to back the money supply is repaid, the currency would be 100% asset backed.
National Bank Note
The Federal Reserve System faced a far more difficult problem when it was instituted in 1913 because people could see immediately there was a difference in the currency.
Prior to 1913, there were three U.S. reserve currencies, all backed by government debt: 1) The National Bank Notes, 2) the United States Notes, and 3) the Treasury Notes of 1890. The reasons for having three distinct reserve currencies were very political and are not relevant to this discussion, but the problem was real: if a new, asset-backed reserve currency was introduced alongside the existing debt-backed reserve currencies, commercial banks would suffer a gigantic loss as the value of government debt was expected to plummet. After all, why would anyone accept a debt-backed banknote when they could have an asset-backed banknote?
United States Note
The problem was solved by issuing a fourth debt-backed reserve currency: the “Federal Reserve Bank Note.” This was used to purchase government debt from the commercial banks which had been required by law to hold the debt to back the National Bank Notes under the Act of 1863. This transferred the liability from the commercial banks to the Federal Reserve. ALL existing reserve currencies were declared to be legally the same as Federal Reserve Bank Notes to prevent people from speculating in the notes and prevent the commercial banks from taking a loss.
Treasury Note of 1890
As the Federal Reserve began rediscounting private sector paper presented by commercial banks, it replaced the debt-backed Federal Reserve Bank Notes with absolutely indistinguishable asset-backed Federal Reserve Notes. This system worked very well until 1917, and the U.S. began preparing for World War I and began monetizing government debt, and then again in 1932 when Keynesian economics mandated a government debt-backed reserve currency so government could control the economy more easily.
Federal Reserve Bank Note
In the 1920s in Germany Hjalmar Schacht did something similar to stop the hyperinflation and replace the worthless debt-backed Reichsmark currency with the asset-backed Rentenmark non-legal tender reserve currency and official new legal tender Reichsmark currency, but that is a different case and has complications we don’t need to worry about.
Yet.
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