In the previous posting in this series we concluded that if a central bank does not adequately serve the purpose for which it was invented, that is, the institution works so as to inhibit or prevent people from realizing their fullest potential as human beings, it must be reformed. Naturally enough, this raises the question as to the special role of a central bank — or any bank, for that matter.
Bank credit being the primary means by which people acquire ownership of the means of production, the need for reform of the central bank must be judged by how well it assists every individual in becoming a direct owner of a meaningful private property stake in income-generating assets. As we saw in the first posting in this series, not only is the right to be an owner inherent, that is natural or absolute, in every human being by definition, ownership of the means of production is the chief means by which each person secures the right to life and liberty, and carries out the task of acquiring and developing virtue — pursuing happiness and safety.
Consistent with the principles of the Just Third Way, we believe that there are four reforms essential to restoring money, credit, and banking to their organic roots and bring these unique institutions back into conformity with the roles they are designed to fill, with special focus on the central bank. Obviously, any reforms must be carried out in a manner consistent with human nature and the demands of the common good, and with ends in view that are equally consistent with nature. The necessary reforms are 1) a mandatory 100% reserve requirement for all commercial banks, 2) a "two tiered" interest rate, 3) widespread direct ownership of the means of production, and 4) direct ownership of the central bank, the primary institution concerned with the means of acquiring and possessing private property, by every citizen.
The 100% Reserve Requirement
As we have seen, banks of deposit automatically back all of their deposits 100% with cash and government securities. This is because a bank of deposit can only lend out what it takes in as a deposit; a bank of deposit cannot create money by issuing promissory notes and backing demand deposits with liens on hard assets.
In theory, however, a commercial bank need not back its demand deposits with anything other than liens on hard assets. For security and to instill public confidence in a commercial bank, however, it is best to have a reserve requirement. For this purpose, 100% cash reserves would be ideal, giving people 100% confidence in the commercial bank. A 100% reserve requirement can be implemented easily with only a few simple changes in the law, e.g., mandating automatic discounting of all industrial, commercial, and agricultural loans and extending the term from the current traditional 90 days to one consistent with the financing period of the capital being financed. (Ninety days is customary only because for centuries most commercial paper was issued for no more than 90 days. This was due to the fact that people in commerce generally saw no need to extend credit for any greater period of time, "settling day" coming at the end of every quarter.)
There was a push to instate a 100% reserve requirement in the United States in the 1930s, headed by the brilliant Henry Simons, founder of the Chicago school of economics. Dr. Simons, however, used the definition of money coming from the British Currency School. Consequently, the "Chicago Plan," while it had limited potential to stop the abuses that contributed to the Crash of 1929, was essentially a reversion to the National Bank system established by the National Bank Act of 1864. The concept consisted largely of a recommendation to convert all banks of issue (commercial banks) into banks of deposit, including the Federal Reserve, thereby removing from the Federal Reserve its special character as a bank of issue for commercial banks, and preventing commercial banks from creating money through the issuance of promissory notes. (See Henry C. Simons, "A Positive Program for Laissez Faire," Economic Policy for a Free Society. Chicago, Illinois: The University of Chicago Press, 1947, 62.)
One of the most serious flaws in the Chicago Plan as outlined by Simons was the fact that, in common with the National Bank Act of 1864 and the British Bank Charter Act of 1844 (on which the National Bank Act of 1864 was modeled), "reserves" were defined as cash and government securities. A special monetary authority was to be appointed to determine the amount of money needed in the economy, and the federal government would issue new debt to allow for any anticipated increase. Simons was never able to develop what he believed to be an effective means to prevent the State from seizing control of the process and using it to monetize its deficits. (Henry C. Simons, "Rules versus Authorities in Monetary Policy," Journal of Political Economy, XLIV, No. 1 (February, 1936), 1-30.) Consequently, despite the urging of such diverse personalities as Irving Fisher and Father Charles Coughlin, Simons refused to endorse his own proposal or push for its implementation. ("Powerful Support Under Way For '100% Reserve Plan'," The Wall Street Journal, 02/19/35, 6)
The 100% reserve requirement under the Capital Homesteading proposal of the Just Third Way is materially different from Simons's Chicago Plan. First, Capital Homesteading has a completely different orientation toward money creation. Under the tenets of the British Currency School, money is presumed to be created first, then savings and capital formation can take place. This was the assumption embodied in the Chicago Plan, in which a monetary authority would estimate the amount of money needed in the economy, create it, and turn it over to the banks to lend out. The sequence in money creation is presumed to be 1) create money, 2) cut consumption and save, 3) locate a project or inventory of marketable goods and services with present value, then 4) invest. As should be obvious, there is a serious danger of either inflation or deflation in this process if the monetary authority happens to guess incorrectly.
Under the tenets of the British Banking School and the real bills doctrine, however, no money is or can be created until and unless a potential borrower brings a financially feasible project to the commercial bank. The present value of existing or future marketable goods and services is determined, and money is created by means of the issue of a promissory note, then invested in the capital project, after which money is taken out of the future stream of income and used to repay the loan. The sequence is 1) locate a project or inventory of marketable goods and services with present value, 2) create money to finance the project in an amount no greater than the present value of the project, 3) invest, and 4) save. As should be equally obvious, there is no danger of either inflation or deflation, as money can only be created as needed in response to existing present value.
While this is the soundest method of creating money, one thing more is needed, and is eminently feasible by using a central bank properly in the way in which it was intended. Instead of having each commercial bank be individually liable for its privately issued promissory notes, a central bank can purchase all loans made by commercial banks to finance industrial, commercial, and agricultural projects that have been properly vetted and collateralized. Thus, just as an individual borrower exchanges his or her personal credit for the less risky and more acceptable institutional credit of a commercial bank, individual commercial banks would exchange their credit for that of the nation itself by discounting all loans at the central bank.
All new money would thus be direct issues of promissory notes not of individual commercial banks, but of the "über" commercial bank, the central bank of the entire country. All currency and demand deposits would automatically pass at par because all would, in effect, be promissory notes of the central bank, and all promissory notes a borrower obtained from any commercial bank would be backed 100% by promissory notes issued by the central bank — an automatic 100% reserve requirement, without the necessity of direct State control of the economy.
In conjunction with a 100% reserve requirement of this nature, the central bank would necessarily have to cease any and all "open market operations," as they are called in the United States. That is, the central bank would not be permitted to hold government debt, whether issued by the government and sold directly to the central bank (primary securities) or "secondary securities" issued by the government and sold to the public and subsequently purchased by the central bank on the "open market." In effect, the central bank's role with respect to the State would be restricted to acting solely as a depository for State funds, and would not be able to issue promissory notes backed by government debt.
The Two-Tier Interest Rate
As we have seen, the most damaging assumption of modern economics and finance, derived from an incorrect (or at least misleading) definition of money, is that capital formation can only be financed out of existing accumulations of savings. Given this assumption, a virtual obsession on the interest rate as the chief means for controlling the money supply and to induce savers to invest is only to be expected.
"Interest," of course, comes from ownership interest, and consists of the return due to an owner of a productive asset by right of private property. Since many people continue to insist, contrary to the evidence, that all capital formation is financed out of existing accumulations of savings, and those savings obviously have to belong to somebody, one of two conclusions is inevitable when trying to manipulate the system in terms of the incorrect understanding of money and the role of savings and ensure a just distribution of income.
One, since an owner is due the income generated by what he or she owns under justice, no one else, especially the State, has any claim whatsoever on the return to capital. The market alone sets the "interest rate" — the share of profits due to someone who provides financing out of an existing accumulation of savings. The interest rate is the market cost of capital. If someone does not have the wherewithal to become an owner of a meaningful stake of the means of production, it must be because he or she is lacking in some essential characteristic or virtue, and consequently can expect nothing.
Two, since the great mass of people have been economically disenfranchised by the concentration of ownership of the means of production, and the tenets of the British Currency School are accepted as virtual Holy Writ, then — so the reasoning appears to go — the principles of the natural moral law, especially liberty, private property, and the pursuit of happiness, cannot be absolute. They must be subject to modification in order to ensure that all human beings can share in the universal destination of all goods — the "generic right of dominion" inhering in each human person.
Both of these orientations are off base. Of the two, however, the latter is more damaging as it attacks and undermines the whole idea of the absolutes that necessarily provide the foundation of the natural moral law. The first orientation is that of capitalism, and widely recognized by thoughtful people as being slightly "off," although most people assume that nothing better is possible. The second is that of socialism, and consequently much more insidious, as it appears, at least on the surface, to be more attuned and responsive to human wants and needs. Nevertheless, socialism attempts to accomplish its end of equal results by overriding or ignoring the basic precepts of the natural moral law. As Heinrich Rommen points out, this leads to "pure moral positivism, indeed to nihilism." (The Natural Law, op. cit., 52.)
The capitalists are right in this: that owners of existing accumulations of savings are due a return on the investment of their savings commensurate with the market's determination of the value of what the savings contributed to the production process. They are, however, wrong in their understanding of money and in the presumed necessity for existing accumulations of savings to finance capital formation. The capitalist is not as essential and irreplaceable as the major schools of economics would have us believe.
The socialists are right in this: that every human being has a right by nature (the universal destination of all goods; the generic right of dominion) to share in ownership of the means of production. Misled by the false assumption of the necessity of existing accumulations of savings to finance capital formation and an incorrect understanding of money, however, they are wrong that the absolute principles of the natural moral law cannot be regarded as absolutes.
Perhaps not surprisingly, the principles of the Just Third Way can be applied in a way to satisfy the expressed concerns of both capitalists and socialists. Obviously, an owner is due a just return for the use of his or her savings in the production process. We have discovered, however, that existing accumulations of savings are not, in fact necessary to finance capital formation. Through the real bills doctrine, commercial banks backed up by the central bank can create money without the necessity of existing accumulations of savings. In The Formation of Capital, in fact, Dr. Harold Moulton proved that using existing accumulations of savings to finance capital formation has a detrimental effect on the capital financed out of existing accumulations of savings as well as the economy as a whole. (The Formation of Capital, op. cit., 29.)
The money created through the application of the real bills doctrine to finance capital formation is based not on existing savings owned by the lender, but on the present value of a productive project owned by the borrower. That being the case, it would be unjust for a lender to charge interest, for the lender does not own the present value that backs the new money created by the loan, although the lender has a lien, a legal claim, on the assets if the borrower fails to repay the money. All interest — profits or "ownership interest" — belongs not to the lender in that case, but by natural right to the borrower, and the borrower is therefore due the full stream of profits or "interest." Thus, all the lender can justify is a service fee sufficient to compensate the commercial and central bank sufficient to cover costs and provide a just profit to the commercial bank, as well as a risk premium to insure against the chance of default.
A Just Third Way solution would thus be a "two-tiered" interest rate. That is, the first "tier" would be set at the market cost of creating new money through the application of the real bills doctrine. This would be restricted exclusively to new money, and all new money would only be created in response to qualified and properly vetted industrial, commercial, and agricultural capital projects — "blue chips." Calling this first tier an "interest rate" is thus a misnomer, for the money would actually be "interest free," both in the traditional sense of lacking a preexisting ownership interest, and the more common sense of a return due to the supplier of existing accumulations of savings. The credit would be "pure," unadulterated by the need to cut consumption in order to accumulate the savings necessary to repay the financing.
The second tier would be the market cost of capital for existing accumulations of savings. This would be for capital projects that did not meet the qualifications for pure credit financing. This would include speculative ventures, unproven technologies, and borrowing by individuals or groups with "bad credit." Also in this category — and probably accounting for the bulk of loans extended out of existing accumulations of savings — would be government borrowing, by nature nonproductive. Finally, consumer borrowing would necessarily come out of existing accumulations of savings, as would all insurance and reinsurance pools, especially capital credit insurance, which as we will see in a subsequent posting should replace the demand for traditional forms of collateral. (The Capitalist Manifesto, op. cit., 243-244; The New Capitalists, op. cit., 60-68.)
Widespread Direct Ownership of the Means of Production
The whole point of this blog series is to present the case for the restoration of property, and examine a viable program to achieve this end. That being the case, a critical reform of the commercial banking system and the central bank is to ensure that all new credit is extended and money created in ways that provide the opportunity and the means for people who currently lack any degree of meaningful ownership of the means of production to become owners of capital.
To be eligible for discounting, then, a loan made by a commercial bank must be made in such a way as to broaden ownership of capital. Unless a loan meets this qualification, the borrower must go to the pool of existing savings. Given a mandatory 100% reserve requirement, a commercial bank could not issue a promissory note for an unqualified loan. The loan proceeds could only be taken out of savings deposited with the commercial bank.
Direct Citizen Ownership of the Central Bank
As we have already seen in this blog series, the best way to secure control over something is by means of the institution of private property. The obvious answer to the problem of the virtual takeover of the central bank by private interests or the State is therefore to vest direct ownership of the central bank in the citizens.
Direct citizen ownership through a form of joint stock company applied universally — rather than the misleading socialist "ownership" in which everyone "owns" because the State owns — is an application of the generic right of dominion (the universal destination of all goods) applied to the particular circumstance of limited, God-created natural resources of which there is not enough to go around if divided equally into sub-economic units, and "social goods" like the power of money creation and the political ballot that by their nature cannot be owned or exercised by some but not by others without inflicting serious harm on the common good.
Commercial banks must continue to be privately owned. Ideally the customers would own these banks in the same way that they own cooperative banks such as credit unions and savings and loans. This, however, is not as essential as direct citizen ownership of the institution charged with regulating the currency, the central bank, removing it from the direct control of the State or State-appointed bureaucrats.
Every citizen should therefore be issued a single, fully voting, fully participating, non-transferable share in the regional Federal Reserve or the equivalent in a particular country. As a right of citizenship, this share must necessarily be issued at no cost to the citizen. When surrendered upon death or transfer of citizenship, however, the shareholder's estate or the shareholder, respectively, should receive the fair market value of the share.
There are a great many details that need to be worked out for a reform of central banking as it is carried out in the world today. There may also be other necessary reforms to conform our money and credit institutions to the demands of the common good as well as our individual wants and needs. These, however, can be developed once the powers-that-be decide to grasp the nettle and deal with our economic problems in a serious and effective manner.