On Usury and Other Dishonest Profit, Part XXXII

Louis Kelso and Mortimer Adler called it "the universal collateralization requirement." It is the single largest barrier that prevents or inhibits the acquisition of a significant capital stake by the great mass of people who lack existing accumulations of savings, and thus interferes with the realization of personal sovereignty and respect for human dignity. Nowhere is this more evident than in the current economic crisis.

The powers-that-be keep complaining that "the banks" aren't lending. Usually they mean that banks aren't allowing consumers to spend increasing amounts of money that consumers don't have, putting them deeper and deeper into debt in order to stimulate the economy by "creating" effective demand. Being oriented toward Keynesian solutions, the powers-that-be don't realize that, in accordance with Say's Law of Markets (which Keynes rejected), the only real way to create effective demand is to produce something, either by means of your labor or your capital, that you can exchange for the productions of others. Anything else is a way of hiding the fact that you are redistributing what belongs to someone else.

That being the case, the only lending that banks should carry out is for investment in new or replacement capital. Replacement capital can come out of existing accumulations of wealth. This is simple justice, for an owner should be permitted free access to the means to maintain and protect his or her current accumulation. Having existing wealth, there is no problem with collateral.

All new capital, however, should be financed out of "pure credit," and in ways that open up access to ownership for those who currently have no capital ownership, or whose ownership is insufficient to generate an adequate and secure income. This does not mean preventing those who are currently wealthy from obtaining more wealth. It does mean putting them on the same basis as everyone else, as Hilaire Belloc recommended in his 1936 essay, The Restoration of Property. This kind of financing is embodied in CESJ's Capital Homesteading proposal.

Unlike Belloc, however, the principles of the Just Third Way as applied in a Capital Homesteading program do not lay heavy burdens on the rich with the intent of bringing them down to the level of everyone else. Capital Homesteading concentrates instead on lifting barriers to full participation in the common good that prevent or inhibit those who currently lack a sufficient accumulation of wealth from using the same mechanisms and receiving the same treatment as the currently wealthy. Instead of bringing down the rich, Capital Homesteading would lift up the poor.

As Kelso and Adler point out in their second book, The New Capitalists (1961), the chief problem in opening up democratic access to the means of acquiring and possessing private property in the means of production is the "universal collateralization requirement." This highlights the significance of the book's subtitle: "A Proposal to Free Economic Growth from the Slavery of Savings." By "savings," Kelso and Adler mean existing accumulations of wealth, not the "future" or "forced" savings that are used to repay a "pure credit" loan. "Pure credit" refers to the process of creating money through the banking system for investment in productive capital without first requiring that savings be accumulated.

Instead (as we've described previously in this series), in the "pure credit" process, 1) a capital project is identified or developed, 2) the prospective investor/entrepreneur presents a proposal to the loan officer(s) of a financial institution that has the power to create money, 3) the proposal is carefully examined ("vetted"), and — assuming that the proposal appears to be sound — money is created by extending credit and printing currency or balancing the loan with a demand deposit on the books of the financial institution. When the capital project begins to generate revenue, the borrower repays the loan, plus remits to the financial institution whatever service charges, risk premium, and interest rate has been added.

The financial institution cancels the amount of the principal (it can't, after all, logically cancel more than that, for that was all the institution created), and books the service charges, risk premium, and interest rate as revenue. When the financial institution's expenses are greater than the amount of revenue generated by operations, the financial institution has a loss or negative net income for the period. When the financial institution's expenses are less than the amount of revenue generated by operations, the financial institution has a profit or positive net income for the period. Unlike a government that has hijacked a central bank, a private financial institution, even though it has the power to create money, cannot create money to cover its own deficits or in response to anything other than a financially sound loan.

In this system, the use of existing accumulations of savings is for collateral. "Collateral" is simply an accumulation of wealth that a borrower pledges to turn over to a lender in the event the borrower fails to repay a loan. Collateral is thus a form of insurance, and almost always consists of accumulated savings of the borrower, or a guarantee by someone with accumulated savings or secure earning power (a presumed ability to save).

The key, then, to obtaining capital credit (or any credit) within the current system is ownership of or access to existing accumulations of savings or the ability to save. That being the case, any mechanism that would eliminate the need to use accumulated savings would open up access to the means of acquiring and possessing the means of production to everyone who currently lacks savings. This, as anyone who reads the daily paper or watches television knows, is virtually the whole of the human race, struggling under a colossal burden of debt incurred for consumption, the interest on which is pure usury.

Essentially, the "proposal" is to replace the "universal collateralization requirement," a form of insurance, with an actual capital credit insurance policy issued by a commercial insurer. In order to spread the risk even further, one or more commercial capital credit reinsurance companies would be established. The premiums for the policies would come out of the usual "risk premium" now included as part of the interest rate charged on all commercial loans.

Initially, all capital credit insurers would, out of common prudence, reinsure all policies until they had built up a sufficient liquidity pool to pay out in the event of loan default. There would be at least two sources of liquidity for the insurance pools of the reinsurance companies. One would be private investors, who, unable to use their accumulations for anything other than speculative investments, gambling, or consumption, would (assuming they are rational) invest whatever they don't use in speculation or consumption either in government securities, or in capital credit reinsurance.

The reinsurance companies would invest their liquidity pools in government securities, treating the insurance pool the same as bank reserves (i.e., either in cash or government securities). Capital credit insurance companies would also be prohibited from investing their insurance pools in anything other than cash or government securities. This is necessary, for the insurance companies would otherwise, like an athlete who bets on him- or herself, be investing in the same thing that they were insuring. This is a type of financial irresponsibility that led to the bankruptcy of AIG and other insurance companies.

We now appear to have all the pieces in place to establish and maintain an economy that does not rely on usury and other dishonest profit to function. What we need now is a feasible program to implement these ideas. We will begin to look at one possible program in the next posting in this series: Capital Homesteading for Every Citizen.