THE Global Justice Movement Website

THE Global Justice Movement Website
This is the "Global Justice Movement" (dot org) we refer to in the title of this blog.

Monday, March 15, 2010

Own the Fed, Part IV: Henry Ford and John Maynard Keynes

The year 1919 was a watershed for the American economy, and thus critical in how the mission of the Federal Reserve System changed so profoundly from providing liquidity directly to the private sector by rediscounting commercial paper, to being the chief financing vehicle for government and indirectly affecting the money supply by manipulating interest rates. Two seemingly unrelated events in that year affected popular perceptions of money, credit, banking, finance, and — most significantly — the institution of private property from which these institutions are derived, to say nothing of the change in the perception of the proper role of the State. The first was one of the most significant, if little understood lawsuits in American history. The second was the beginning of the career of the most influential economist of the 20th century. The lawsuit was Dodge v. Ford Motor Company (204 Mich. 459, 170 N.W. 668. (Mich. 1919)). The economist was John Maynard Keynes.

Of the two, the lawsuit may have caused the most damage. The issues involved struck at the architecture of the social order: the legal system that — presumably — defines and protects each person's natural rights to life, liberty (freedom of association), property, and pursuit of happiness (the acquisition and development of virtue), and in theory restricts the role of the State to the common, not each person’s individual good. Economists, for all their theorizing, ultimately have to deal with the formal structures of society that, in significant measure, define the market and the role of the State in the economy. Had not the legal system already accepted the tenets of the mercantilist Currency School that underpins Keynes's theories and undermines the institution of private property and gives too great a role to the State, Keynes could have theorized to his heart's content and never achieved more than a few ripples in the relatively small pond of academia.

It seems not only a paradox, but an astounding contradiction to claim that Henry Ford was a prime mover in the virtual destruction of private property for the great mass of people not only in the United States, but throughout the world. It might not be too much of an exaggeration to say that Ford did more to abolish private property in the means of production as a widespread institution than anything Karl Marx, the Currency School, or Keynes managed to accomplish.

This comes across as almost heretical, for Ford epitomized American Capitalism the way Thomas Edison was the exemplar of American Ingenuity. The hold that these two men had on the American psyche was such that when the novelist Garrett P. Serviss wrote a sequel to H. G. Wells's War of the Worlds (1898) in which humanity took revenge for the alien invasion of Earth, he titled it, Edison's Conquest of Mars (1898). Nevertheless, Henry Ford, the virtual "high priest" of capitalism, was responsible for undermining the very system to which he credited his success. This is consistent with the remark attributed to Karl Marx, "The last capitalist we hang shall be the one who sold us the rope."

The story begins in January of 1914 (if not earlier with the formation of his character and attitudes) when Ford decided to raise the basic wage rate at the Ford Motor Company from $2.34 per day to $5.00. (Robert Lacey, Ford, The Man and the Machine, 1986.) Initially the raise was limited to certain classes of machinists and widows with children. Ford, of course, was actuated by the best of motives. He seems to have honestly believed that he was a public benefactor.

Not unexpectedly, the increase caused so much envy among all workers that Ford was forced to make $5.00 the basic minimum across the board. Workers employed at other auto plants and unemployed people from across the country descended on Ford in search of jobs. This caused riots. A number of small businesses located near the Ford plant were destroyed during the disturbances.

Other auto manufacturers were forced to raise their pay rates to keep qualified workers. The increase in pay unlinked to increases in productivity started an inflationary wage/price spiral that has lasted to the present day and is, in part, responsible for the current condition of the American automobile industry. Exacerbated by the inflationary monetary policies instituted in the First World War caused by using the new Federal Reserve System to finance the war, Ford's unilateral wage increase eventually resulted in a typical autoworker in 2009 making in wages and benefits more than twice in one hour what an autoworker made in 1909 in an entire week — Saturdays included.

Henry Ford had the opportunity in 1914 to spread ownership out among his workers. This would have shifted the practice of raising pay by relying on increasing fixed wages and benefits, to variable profit sharing from the bottom line. Instead, Ford's actions had the effect not only of locking his workers permanently into the wage system and shutting them out of almost any chance of becoming owners of even a small capital stake, but of convincing most Americans that the wage system is the only system. Then, five years later, in an effort to protect his own private property interest, Ford virtually destroyed private property itself with the concurrence of the courts.

Possibly because he mistrusted banks (which he appears to have believed were controlled by an international Jewish cabal), Ford decided to finance a plant expansion using retained earnings instead of selling new equity or borrowing the money. Some of the minority owners (i.e., owners with less than a controlling interest), the Dodge brothers, protested. They weren't interested in why Henry Ford refused to borrow from banks or issue new shares to finance plant expansion. They wanted the dividends to which they were entitled under the traditional rights of private property. Henry Ford refused to pay dividends, and the Dodge brothers sued.

The case, Dodge v. Ford Motor Company, became a landmark. Among other issues, the court redefined the traditional right to receive the "fruits of ownership" (i.e., income from what is owned — dividends) for minority shareholders as limited to receiving dividends only if the distribution wouldn't harm the company (the "Business Judgment Rule"), and to sell their shares if they weren't happy with the dividend policy of the majority owner(s).

The court ruled, in effect, that minority shareholders are able to enjoy their full "fruits of ownership," including the right to receive any and all income generated by what is owned, only if the majority owner so agrees. That is, the majority owner(s) in the person of the Chairman of the corporate Board of Directors alone has the right to set dividend policy for a company, and does not need the consent of a minority owner or owner(s) to withhold that which belongs to the minority owner(s) by natural right if, in the judgment of the Board of Directors, the distribution of dividends would harm the company.

Thus, according to the Michigan Supreme Court, someone who owns less than 50% of an asset doesn't really own it in the full sense of the term. Anyone who owns more than 50% of that same asset can withhold some or all of the rights of ownership from the minority owner or owners, especially the right to enjoy the income generated by the asset, at his or her discretion.  Ironically, the Michigan Supreme Court ordered Henry Ford to pay out a special dividend totaling in the millions because he had not proved his case that it was in the best interests of the shareholders that cash be accumulated in the company.

Thus, it was not the fact that Ford had refused to pay dividends that mattered, but that he had refused to pay dividends when there was an obvious surplus, and he could not prove that payment of dividends would harm the company.  Had Ford been able to "prove" that payment of the special dividend would, in his judgment, harm the company by depriving it of funds presumably required for growth (the usual argument made — and accepted — today in the belief that savings must be accumulated before forming capital), he could have withheld any and all dividends.

The decision by the Michigan Supreme Court thereby redefined what it means to be an owner by shifting the burden of proof whether the refusal to pay dividends violated shareholder rights.  Boards of Directors did not have to justify non-payment of dividends.  Instead, the shareholders had to prove that the refusal to pay dividends would not harm the company — and, logically, it is impossible to prove a negative. This struck directly at what has long been considered an inalienable right and the foundation of civil society itself — to say nothing of being the basis of the real bills doctrine that provides the theoretical basis for central banking.

Unfortunately, many commentators have obscured the true import of the ruling by focusing on a relatively minor issue that was raised as part of the plaintiffs' case. This was whether Henry Ford had the right to lower the price of Ford automobiles in order to increase sales, accumulate cash, and keep as many people as possible employed — and lower corporate earnings. As Ford had declared in a newspaper interview three years previously, "My ambition is to employ still more men, to spread the benefits of this industrial system to the greatest possible number, to help them build up their lives and their homes. To do this we are putting the greatest share of our profits back in the business." (Interview in The Detroit News, August 31, 1916.)

The court agreed that a corporation was not to be run as a charitable enterprise, but for the benefit of the shareholders. Most conventional analyses of the case stop at this point, without realizing the import of the fact that Henry Ford did not base his defense on his stated ambition to be a public benefactor by creating jobs, but on the "business judgment rule." Thus, if the individual elected by the shareholders (who happened to be Henry Ford, as he retained the majority block of shares) decided it was in the best interests of the company — and therefore the shareholders — to stop payment of dividends and deprive minority shareholders of their rights, the minority shareholders had to take whatever the majority owner(s) chose to dish out.

The alternative was to exercise their "take-it-or-leave-it" right to sell their shares and wash their hands of the whole business — in other words, exercise their property rights to become non-owners. In effect, Henry Ford claimed that he was protecting the best interests of the shareholders by depriving them of the exercise of their natural rights, that is, by treating them as less than human.  While Henry Ford failed to prove his case, subsequent generations of boards of directors learned the lesson, and (bolstered by widespread acceptance of the erroneous belief that new capital can only be financed out of existing savings) have no difficulty in persuading the courts that it would harm both the company and the economy as a whole to pay dividends.

What is also frequently ignored in analyses of the case is the fact that Henry Ford had dismissed another right of private property, that of control. He had previously blocked every effort of the minority shareholders to have input into decisions and exercise some degree of control over the business, such as design improvements and marketing strategy. This was particularly egregious with respect to the Dodge brothers, who owned the next largest block of shares (10%) after Henry Ford, and who were increasingly unhappy with Ford's dictatorial actions.

Consequently, prior to their lawsuit over Ford's restriction of dividend payments, the Dodge brothers began setting up their own automobile manufacturing company in secret, using their Ford dividends to finance the effort. Ford got wind of this and began withholding dividends. Ford was also suspected of wanting to reduce the price of Ford automobiles as a way of justifying the proposed reduction in dividend payouts and reducing the company value per share to make even selling the shares less profitable to the Dodge brothers.

After the Michigan Supreme Court ruled against him, Ford threatened to set up another rival automobile manufacturing company, probably to be wholly owned by Ford personally, apparently as a way to compel the Dodge brothers to sell their shares back to the Ford Motor Company at the reduced value per share that Ford had manipulated. In this he was successful — and thereby undermined another right of private property, that of disposal, by taking away the Dodge brothers' free choice in the matter of whether or not to sell their shares.

It was, however, a Pyrrhic victory. The Dodge brothers used the proceeds of the forced sale to complete setting up their own automobile manufacturing company. They soon designed and marketed an automobile that many car enthusiasts still consider one of the best popular vehicles ever built, the 1926 Dodge. This made the venerable Model T Ford, the basic design of which Henry Ford had resisted changing for twenty years (1908-1927), obsolete. Henry Ford was forced to invest vast sums in developing a competitor to the Dodge product, and to spend millions more retooling his factories to produce the Model A in 1928. His refusal to share power and reluctance to pay dividends to minority shareholders cost Henry Ford a huge fortune, and ensured that his company lost its position as the world's leading automobile manufacturer.

The contribution of John Maynard Keynes to Henry Ford's accomplishment was to legitimize it by offering a theoretical basis to justify the abolition of private property and the undermining of the free market — and thus the negation of the private sector role of the Federal Reserve and the glorification of the State. In 1919 Keynes published the book that established his reputation as one of the leading economists in the world: The Economic Consequences of the Peace. Just as Karl Marx summarized the theory of communism in a single sentence, "The abolition of private property" (The Communist Manifesto, 1848), Keynes encapsulated his school of economic thought by declaring: "The immense accumulations of fixed capital which, to the great benefit of mankind, were built up during the half century before the war, could never have come about in a Society where wealth was divided equitably." (
The Economic Consequences of the Peace, 2.III.) In that brief sentence can be found the justification for Keynes's rejection of the real bills doctrine, the related Say's Law of Markets on which the real bills doctrine is based, the redefinition of money and interest, intrusive State control of the economy — and egregious misuse of the Federal Reserve System.

The reasoning is relatively straightforward. If "wealth was divided equitably," owners would use the income generated by their capital for consumption. Businesses would have to borrow money from commercial banks in order to finance capital formation — money that commercial banks have the power to create by discounting, and to back up with the "faith and credit of the United States" by rediscounting at the Federal Reserve. To Keynes, however, using capital income for consumption was an improper use of that income, as he made clear a decade and a half later in his General Theory with his reference to "functionless investors." (VI.24.ii.) Money creation by the commercial banks backed up by the central bank through the application of the real bills doctrine is, according to Keynes, impossible . . . even though history has proved time and again that commercial banks do, in point of fact, create money all the time, and legitimately so if the money is created in direct response to capital projects that generate their own repayment, and the assets financed are linked to the new money created by private property. (See Harold G. Moulton, The Formation of Capital, 1935.)

The problem was that Keynes accepted the tenets of the British Currency School without question. With respect to Dodge v. Ford Motor Company, the most important of these tenets (and the one disproved by the real bills doctrine and Say's Law of Markets) is that it is impossible to finance new capital formation without first cutting consumption, accumulating savings, then investing. The job of a central bank in Keynes's theory is not to finance new private sector capital — again, that (according to Keynes) is impossible — but to redistribute purchasing power through inflation and "forced savings" by monetizing government deficits, thereby generating full employment — if we define "full employment" as a wage system job for everyone, or nearly everyone.

Given the assumption that only existing accumulations of savings can be used to finance capital formation, ownership of the means of production must be concentrated in as few hands as possible. This ensures that the owners of capital cannot, despite their best efforts, spend all of the income their capital generates, and are forced to save and reinvest the excess, just as Henry Ford proposed. The greater the concentration, the greater the excess, and the greater the "immense accumulations of fixed capital" that presumably benefit humanity that can be built up. In this framework, paying dividends changes from an exercise of the natural right to be an owner and thereby enjoying the fruits of ownership, to being a counterproductive act that harms, even halts economic growth. (This belief was, again, completely disproved by Moulton in The Formation of Capital, but that had no effect on the fixity of the belief, or the religious devotion with which academic economists and government policymakers have adhered to it.)

Thus, thanks in large measure to the combined prestige of Henry Ford and John Maynard Keynes, the effective abolition of private property for the great mass of people became enshrined in law, economic theory, and fiscal and monetary policy — and thus into the United States Internal Revenue Code and, most especially, into the policies of the Federal Reserve System. The central bank of the United States now had both legal and theoretical justification in addition to political expedience as reasons to change its mission from providing adequate liquidity to the private sector for industrial, commercial, and agricultural projects, to funding government deficits and attempting to control the economy by imposing effective State control of money and credit.

An owner has the right to the profits generated by what he or she owns. Denying this right, as Henry Ford tried to do to the Dodge brothers, and for which Keynes provided the presumed theoretical basis, however unsound, abolishes private property to that degree. Common myths about how capital formation is financed provide the justification for this undermining of a natural right. There are two essential reasons for this.

• First, of course, capital isn't usually financed out of existing accumulations of savings — directly. The chief use of savings (which necessarily equal investment, as Keynes agreed, indeed, insisted on) is as collateral for debt financing. Henry Ford undermined the natural right to private property in two ways by accumulating cash to finance plant expansion: 1) he denied the Dodge brothers their fruits of ownership by attempting to withhold dividends, and 2) he violated principles of sound finance embodied in the real bills doctrine and Say's Law of Markets, thereby monopolizing access to the means of acquiring and possessing private property, necessarily throwing the economy out of equilibrium.

• Second, Henry Ford's chosen method of concentrating ownership — and thus power — in his own hands guaranteed that he would be accountable to no one for any of his actions. By concentrating ownership, Ford effectively negated others' right to be an owner, and actually went so far as to work to strip others not only of the rights of ownership, but of ownership itself.
While not generally recognized, Dodge v. Ford Motor Company and The Economic Consequences of the Peace helped set the stage for the Crash of 1929 and the current financial crisis. It did this by shifting the incentive for share ownership from anticipation of a future stream of dividends, to speculation in the value per share itself. "Investment" became redefined in the popular mind (and in that of many financial professionals) as buying and selling in anticipation of a rise or fall in the value per share, not in putting resources to work in a productive endeavor. The result was a near-total divorce of "investment" and share ownership from the revenue stream generated by profits of production.

Thus, between the two of them, Henry Ford and John Maynard Keynes managed to separate ownership from the rights of ownership. Ford did this directly, by taking away the rights of minority owners to a pro rata portion of control and income generated by what is owned. Keynes did this indirectly, by separating issuance of money from direct ownership of the assets that necessarily back the money. Ford and Keynes can be given credit for helping to destroy private property as a widespread institution in the modern world.