On Usury and Other Dishonest Profit, Part XIX

You can get out of debt by spending more money . . . or so Keynesian economics would have us believe. The only thing that happens, however, is not a diminution of debt, but a transfer of existing and new debt, a shuffling of liabilities. For example, a government bailout doesn't eliminate debt, but transfers the debt from a private company to its new owner, the State. The government borrows money to fund economic stimulus packages in order to increase effective demand in the economy.

Increasing effective demand encourages companies to borrow money (i.e., go into debt) to create jobs. Job creation entices consumers to borrow money to purchase goods and services on the assumption that future wage income will allow them to pay back the loan. The government then engages in a new series of bailouts to transfer private debt (and ownership) to the State, beginning the cycle all over again.

Clearly this is insane, or (to use the technical term), "nuts." A government or a private company can't decrease liabilities by increasing them. Neither can people increase effective demand (disposable income) unless they have the means to engage in production, as Jean-Baptiste Say pointed out, by means of their labor, capital, or land.

Unfortunately, in the Keynesian paradigm, the only way to finance capital formation to increase production is to cut consumption and save. Since saving decreases effective demand (i.e., cuts consumption), this makes the investment in new capital non- or less feasible. Thus, as we have already seen, the only way in the Keynesian paradigm to keep things going is to engage in redistribution of what already exists, either directly through the tax system, or indirectly through inflation.

The sane alternative is to discard the Keynesian paradigm and start using commercial banks, that is, banks of issue, in the way they were designed and intended to operate. This is what Dr. Harold G. Moulton advocated to finance recovery from the Great Depression following the Crash of 1929 in his short book, The Formation of Capital (1935).

A commercial bank operates in conformity with something called the "Real Bills" doctrine. Unilaterally rejected by Keynes & Co. as "discredited" (without giving any reasons), the Real Bills doctrine is that a commercial bank (as opposed to a bank of deposit) can create money without inflation, as long as the new money is backed by existing marketable goods and services, or the present value of a reasonably-expected future stream of income generated by the production of marketable goods and services.

The Real Bills doctrine, in short, recognizes that, because production = income, this thing we call "money," that allows us to transfer claims on production between parties to a transaction, is derived from production itself — not from government debt. Money is, in fact, a "derivative" of production. Money is illegitimate (i.e., counterfeit — whether legal or illegal) if not backed by the present value of existing marketable goods and services, or the present value of a reasonably-expected future stream of income generated by as-yet unproduced marketable goods and services. Money is legally defined as anything that can be used in settlement of a debt. It doesn't have to be in the form of government-issued currency, or even in any physical form at all. Money can take the form of an oral agreement or a handshake, if both parties reach a "meeting of the minds."

What, then, is "currency"? Currency is "current money," i.e., something that has a standard value in an economy, and passes from hand to hand without having to be revalued every time a transaction takes place. Currency can (and most often is) regulated by the government, but it doesn't have to be. Currency is simply a socially-supported convenient form of money.

Legal tender, despite the mystique that has developed around those two words, simply refers to the fact that the form of money to which legal tender status has been attached (and it doesn't even have to be a recognized currency) cannot be refused if tendered in payment of a debt. There appear to have been some statutory changes in various countries that limit the application of legal tender status (nobody ever said the interpretation or enforcement of laws was consistent or logical — just that it is supposed to be so), but the essential principle remains. It is altered or amended for the sake of expedience, e.g., the IRS would find itself in grave difficulties if everyone paid his or her taxes in cash, to say nothing of the fact that there isn't enough legal tender currency in circulation for everyone to pay his or her taxes in cash. This does not, however, change the basic principle: legal tender is that which cannot be refused in payment of a legal debt.

A commercial bank, therefore, can create money by taking a lien on existing inventories of goods and services, or the present value of future production of inventories of marketable goods and services that a prospective borrower brings to the bank. The bank exchanges a demand deposit or (formerly) prints bank notes, and loans it to the borrower. The borrower takes the funds and invests in some project expected to generate a future stream of income.

As the income comes in, the borrower repays the bank, plus whatever service fees, interest, and risk premium is charged on the loan. For its part, the bank cancels the loan principal and the funds used to repay the principal — the amount of money created to finance capital formation. The additional money the bank takes in debt service (service fees, interest, and risk premium) is "pocketed" by the bank and booked as revenue. Out of this, the bank meets its expenses, retains earnings, or pays out profits in the form of dividends. What money the bank doesn't cancel reenters the economy as the bank expends the funds.

Herein we see the paradox of commercial banking. While not usurious, commercial banks engage in usury — even though (in theory) they lend money only for productive projects, and taking a profit where a profit is generated is perfectly legitimate, even moral. This is a right of private property. A right implies the functioning of justice, a moral virtue. Thus taking a profit ("enjoying the fruits of ownership") is not only allowed, it is virtuous in the Aristotelian sense.

How this is possible will be examined in the next posting in this series.