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.

Friday, April 30, 2010

News from the Network, Vol. 3, No. 17

In keeping with the view that the State can solve everything, and the Federal Reserve can do whatever the State cannot (yes, we realize the logical absurdity of the statement, but you can verify these beliefs just by reading the paper or watching the news), the push to "do something" to or about Goldman Sachs has intensified.

The situation is fraught with ambiguity. On the one hand, the Goldman Sachs people are probably correct. They (likely) did nothing illegal. On the other hand, they clearly betrayed the trust that their clients put in them. That's not illegal, either, or we'd have to indict every politician in Washington. On still another hand (clearly we're dealing with the Mutant Monster into which the economy has developed under the tenets of the Currency School) what they did could be regarded in certain circumstances as unethical — except that they were only selling a product to presumably knowledgeable people, and it is a little gray just how far they are obliged to disclose how lousy their product really is.

On the other hand . . . but you get the idea. The problem is that this is the kind of circumlocutions and problems you deal with when the system is not solidly grounded on basic moral principles found in the natural moral law and as applied in the three principles of economic justice on which binary economics is built. You have to do stranger and stranger things, and get further and further removed from reality to make the system even appear to work — which, ultimately, it can't, given the separation from the economics of reality, as well as reality itself.

Here are some of the events that have happened as we work to try and wake people up to the fact that they are going to have to start facing reality sooner or later — preferably sooner:
• We're a little bit late acknowledging it (especially since we didn't know about it until this week) but Mr. Samuel Allen of St. Maarten Island in the Netherlands Antilles published a very good review of Michael D. Greaney's book, In Defense of Human Dignity (2008) on Nor did Mr. Allen stop there, but added the book edited by Dawn K. Brohawn, Journey to an Ownership Culture, and dropped a line about Rodney Shakespeare and Peter Challon's book, Seven Steps to Justice.

• A potential candidate for president of Zambia has been reading the material on CESJ's website, especially the programs relating to rebuilding an economy from the ground up. The candidate believes that the Just Third Way is just what his country needs. As he stated, "It is hard for me to put into words the joy I felt as I read through the material on the CESJ website. Your writings have been keeping me up very late into the night and early hours of the morning. . . . Please excuse my excitement but I have been so refreshed by what I have read (and by your reaction) and feel now, more than ever, that the call to leadership was indeed one that I could no longer ignore." Is there anyone out there suffering from the delusion that Africa is the "dark continent"? It appears that there is some leadership coming out of there that can teach the rest of the world a thing or two.

• His Holiness Pope Benedict XVI spoke earlier today to a gathering at the Pontifical Academy of Social Sciences. In remarks clearly directed to the worsening European financial crisis, the pope explained how "the Church, based on her faith in God the Creator, affirms the existence of a universal natural law. ... As part of the great heritage of human wisdom, the natural moral law, which the Church has appropriated, purified and developed in the light of Christian revelation, serves as a beacon guiding the efforts of individuals and communities to pursue good and to avoid evil, while directing their commitment to building an authentically just and humane society". As His Holiness continued, "Among the indispensable principles shaping such an integral ethical approach to economic life must be the promotion of the common good, grounded in respect for the dignity of the human person and acknowledged as the primary goal of production and trade systems, political institutions and social welfare. In our day, concern for the common good has taken on a more markedly global dimension. It has also become increasingly evident that the common good embraces responsibility towards future generations; intergenerational solidarity must henceforth be recognised as a basic ethical criterion for judging any social system." Obviously, CESJ's fundamental grounding in the natural law is a common starting place. It is only a matter of educating the man, which requires gaining his ear.

• We just received a copy of Lydia Fisher's Cinderella of Wall Street, published in September of last year. We haven't had time to do an in-depth reading, but so far it looks pretty good. Ms. Fisher clearly knew nothing of CESJ and the Just Third Way when she wrote the book, but there is, nevertheless, a significant measure of congruity between her approach and ours, especially the acknowledgment of the importance of universal moral principles not just to guide personal behavior, but public life and, especially, business. The author integrates her personal life holistically into an intensely personal story, but still makes the convolutions of what has been going on in the Wall Street secondary market understandable. The author pinpoints one of the chief causes of the present chaos in the 1999 full repeal of the Banking Act of 1933 ("Glass-Steagall"), a judgment in which we fully concur. Among the personal information discovered was that, although personally acquainted with the author, this writer was unaware that Ms. Fisher was named after the heroine, Lygia, in one of his most favorite novels, the great Heinryk Sienkiewicz's Quo Vadis. (When in Rome, this writer made a point of visiting both Quo Vadis chapels.) The downsides (which can safely be ignored): 1) For such a friendly and approachable book, the typeface is "unfriendly," that is, it appears to have been chosen more for art's sake than for readability. It tends to tire the eye. 2) The current financial system, based ultimately on principles that are essentially antithetical to the book's clear moral orientation, is not given the lack of credit it deserves. (Obviously these downsides are, as Damon Runyon would put it, "pretty small potatoes.")

• Work proceeds apace on the republication of Harold Moulton's The Formation of Capital from 1935. We're working on refining the foreword, which explains the importance of the book for the Just Third Way and binary economics.

• The "grand work" on the Federal Reserve System is nearly two-thirds complete. Most of what has been written has been posted on this blog in the two "Own the Fed" series.

• As of this morning, we have had visitors from 46 different countries and 46 states and provinces in the United States and Canada to this blog over the past two months. Most visitors are from the United States, Canada, the UK, Australia, and India. People in Norway, Guatemala, Venezuela, Maldives, and Pakistan spent the most average time on the blog. The most popular posting continues to be "Kemp Harshman, Soldier of Justice," followed by "Full Employment" in the "Own the Fed" series, Guy Stevenson's "Expanded Capital Ownership Now," "The Great Society" in the "Own the Fed" series, and "Thomas Hobbes on Private Property."
Those are the happenings for this week, at least that we know about. If you have an accomplishment that you think should be listed, send us a note about it at mgreaney [at] cesj [dot] org, and we'll see that it gets into the next "issue." If you have a short (250-400 word) comment on a specific posting, please enter your comments in the blog — do not send them to us to post for you. All comments are moderated anyway, so we'll see it before it goes up.


Thursday, April 29, 2010

Own the Fed — the Program, Part XI: The Two-Tier Interest Rate

The period immediately preceding the Crash of 1929 was marked by excessive use of bank credit to finance purchases of speculative equity issues on the secondary market. What puzzled the authorities and experts (at least those trapped within the tenets of the Currency School) was the fact that there also appeared to be plenty of credit for genuinely productive business purposes. According to the theory enshrined in economic dogma as the "production possibilities curve," there exists only so much credit, representing the supply of loanable funds — existing accumulations of savings.

As the prevailing (and incorrect) theory has it, printing money or creating demand deposits can shift existing savings around through the redistributive effects of inflation and deflation ("forced" or "involuntary" savings; see Keynes, General Theory, op. cit., II.7.iv, IV14.i, V.21.i,; Harold G. Moulton, George W. Edwards, James D. Magee, Cleona Lewis, Capital Expansion, Employment, and Economic Stability. Washington, DC: The Brookings Institution, 1940, 26). Within the framework of the Currency School, the process of money creation — or, more accurately, the creation of more currency or currency substitutes — cannot bring additional savings into existence out of nothing.

Currency School theory and all the schools of economics that accept the principles of the Currency School ignore the bulk of the real money supply. This is the promissory notes and other negotiable instruments collectively known as real bills that can be issued on the basis of the present value of future marketable goods and services. The only way within the paradigm bounded by the tenets of the Currency School to finance new capital formation is to cut consumption, save, then invest.

Coincident with the financial system's slavery to existing accumulations of savings is the failure to distinguish between good and bad uses of credit. Driven solely by profits, with little regard for how profits are generated or where they come from, essential principles of ethics — the precepts of morality, usually justice — are ignored or forgotten. If it is possible to squeeze money out of something, whether or not anything of value was produced by the activity, then the only standard is how much money can be accumulated.

True, the absolute belief that capital formation can only be financed out of existing accumulations of savings does not necessarily lead to justifying any and all means of getting money — but it doesn't help any, either. Within the various paradigms dictated by this basic precept of the Currency School, those with vast wealth are considered essential to financing new capital formation and thus providing the jobs by means of which the vast bulk of humanity gains subsistence. (See Keynes, The Economic Consequences of the Peace, op. cit., III.2.)

Such is the corrupting influence of concentrated power, especially economic power, that the "slavery of savings" quickly turns into "slavery to those with savings." Whether a small private elite, or the State itself, whoever controls access to savings controls everything. As Mayer Anselm Rothschild is alleged to have declared, "Give me control over money and credit, and I care not who makes the laws." Those with access to savings are venerated, even worshipped outright as a special breed, becoming an unelected and, in many cases, unappointed economic dictatorship. They come to view their activities as a form of conquest of the system, of others in their milieux and, finally, of the rest of humanity.

People come to believe (or, at least, convince themselves) that greed is not only good, it is the greatest virtue. Greed alone is held to be responsible for driving these exceptional individuals to accumulate more and more. Greed makes it possible for people to finance new capital formation, create jobs, save the economy, and therefore the nation. Those who have indulged their greed to the maximum become viewed as saviors, and then as gods. If greed is good, then Greed is God, "for only God is good."

In reaction, if not outright disgust, people whose moral compass has not been entirely decalibrated begin viewing all profit as a manifestation of greed, and all the laws of economics as necessarily wrong. Everything associated with the system that enshrines greed as god, whether the business corporation, wealthy or well-off individuals, mass production — anything that excites the ire of such self-appointed moral authorities — is necessarily evil.

People with some vestiges of morality, though often lacking in reason, quite properly reject capitalism for its emphasis on, even worship of greed. Unfortunately, they often then overcompensate and assume that socialism based on envy (usually under another name or in a different outward form) is the only acceptable system. Private property must be abolished in its present form, by which they usually mean in its substantial nature. Since obviously not everyone can own the means of production, the right to be an owner must not truly be a natural right, inherent or absolute in every human being. Instead, it must be prudential matter, a manmade expedient or, as one commentator declared, "a right, but not an absolute right."

The descent into the envy of socialism derives from the assumption that people should get what they need, not what they are due in exchange for their inputs, and that distribution on the basis of need is an application of justice. This, in turn, leads to other conclusions, equally erroneous. For example, since most people do not have accumulated savings, they cannot participate in the economy as owners. Most people are therefore restricted to supplying labor. Since the world was made for everyone, that must mean that capital is not truly necessary for production, and labor alone is ultimately responsible for all production. If God had meant everyone to own capital, He would have given them savings.

Thus, the flawed assumptions of the Currency School, taken and worshipped as absolutes — especially the presumed necessity for using only existing accumulations of savings to finance capital formation — leads to a pendulum swing between greed and envy. The action finally settles into the gray sameness of the Servile State in which both Greed and Envy join and share the throne. Greed and Envy become a Janus, presenting two faces to the world. Depending on how you choose to look at it, the system's slavery to existing accumulations of savings is either good or evil, but you're stuck with it, and there is no way out.

Both the "greedists" and the "needists" (The Capitalist Manifesto, op. cit., 97; also Two-Factor Theory, op. cit., 12-29) make the same fundamental error. Which side they take usually depends on whether they have separated faith from reason, or reason from faith. Since faith enlightens reason, and reason guides faith, separating one from the other splits the human mind in two, as G. K. Chesterton characterized the abandonment of the Intellect as the basis of the natural law in favor of the Will, epitomized by the claims of Siger of Brabant in his debate with St. Thomas Aquinas. As Chesterton explained the issue,
Siger of Brabant said this: the Church must be right theologically, but she can be wrong scientifically. There are two truths; the truth of the supernatural world, and the truth of the natural world, which contradicts the supernatural world. While we are being naturalists, we can suppose that Christianity is true even if it is nonsense. In other words, Siger of Brabant split the human head in two, like the blow in an old legend of battle, and declared that a man has two minds, with one of which he must entirely believe and with the other may utterly disbelieve. (G. K. Chesterton, St. Thomas Aquinas: The "Dumb Ox." New York: Image Books, 1956, 92-93.)
A bad economic assumption — the presumed absolute necessity of existing accumulations of savings to finance capital formation — thereby leads to bad reason and bad faith. The shift in the basis of the natural moral from Intellect to Will (see Rommen, The Natural Law, op. cit., 51-52) provides the philosophical framework (such as it is) to justify both greed and envy. The same bad economic assumption also leads to bad monetary and fiscal policy, especially when it comes to the prevailing fantasy that the federal government and the Federal Reserve together actually (and effectively) control the economy, as we explained in the first posting in this series.

Thus we see that within the Currency School model the only way to inhibit or reduce the use of bank credit for speculative purposes is to discourage all uses of credit. This leads automatically to the belief that the central bank, the Federal Reserve System, can reduce speculative uses of credit (and, unfortunately, productive uses of credit at the same time) by raising interest rates to eliminate — presumably — the possibility of speculative bubbles in the economy. Interest rates are thereby construed as a different form of "sin tax," that is, an excise tax levied to discourage what those in power view as objectionable behavior, such as smoking, drinking, gambling, and so on. Legislators often find sin taxes both lucrative and profitable, especially when they become desperate for revenue.

The same technique is applied when Federal Reserve authorities believe that the economy is becoming "overheated," that is, economic growth is going at too fast a rate. This, presumably, is fertile ground for speculative bubbles, and needs to be headed off at all cost. Stock market gambling evidently being an objectionable activity, imposing a sin tax in the form of higher interest rates presumably solves the problem, although it has the undesirable side effect of also punishing presumably unobjectionable genuinely productive activity.

The Obama administration has refined this approach. It has recently started calling for a "bailout tax" on financial institutions. As reported in an editorial in The Wall Street Journal, this will (presumably) "discourage excessive risk-taking and prevent systemic risk." ("Global Bank Heist," The Wall Street Journal, 04/29/10, A18.) While the editorial does not refer to the bailout tax as a sin tax, it points out that the proposed tax would probably not discourage bailouts or discourage the activity that leads to the presumed necessity for bailouts. Further, the proceeds would probably not be used to bail out banks, any more than the Social Security trust fund was safe from being pillaged to finance other government expenditures.

Even the faulty reasoning behind the manipulation of the interest rates and the wealth sin tax — having enough wealth to excite the envy of others evidently constituting a sin — does not explain, however, the rationale behind the support that the Federal Reserve authorities have given to bringing the stock market back to its old levels as fast as possible after the precipitous decline that bottomed out in March and April of 2009. By any measure, the "miraculous" recovery of the secondary markets since that time, far from the great good it's being trumpeted, is actually a very dangerous sign of much worse things to come.

For the purposes of comparison, let's take a look at events following the 1929 Crash. In September of 1929 the Dow hit an all-time high of $381.17. In the darkest days of the Great Depression, the Dow was down to $41.22. The Dow did not recover its pre-Crash level of $381.17 until the mid-1950s, a full quarter century after the Crash.

In comparison, the Dow reached an all-time high of $13,390.01 in October of 2008. The Dow then fell to $7,062.93 by March of 2009. By the middle of April of 2010, the Dow was at $11,145. This was touted as an astonishing recovery. The Federal Reserve authorities abandoned their cautious optimism and announced that the recovery was well under way and the worst was definitely over. The strength of the American economy was demonstrated by the fact that the Dow took a little over a year to recover 83% of its former high, doing what it took the economy from 1930-1955 — twenty-five years — to accomplish after the Crash of 1929.

There are other significant differences between the situation in the 1930s and that of today, all of them involving disastrous, as opposed to merely terrible monetary policy. Much of the problem, however, seems to boil down to one thing. Despite the fact that massive money creation for speculative purposes was one of the driving forces behind the Crash of 1929 as well as the sub-prime mortgage meltdown of 2007, government policymakers and Federal Reserve authorities seem convinced that massive money creation for non-productive purposes is the way to advance economic recovery — only they refuse to admit that is what they are doing.

There was, of course, massive money creation by the federal government and backed by debt during the Great Depression. The money, however, financed government spending and boondoggling — artificial job creation. The money went directly into increasing effective demand. Moulton pointed out this was backwards, that increased production would increase effective demand, but there was a temporary decrease in unemployment. Unfortunately, Federal Reserve authorities (just as today) were unable to distinguish between productive uses of credit and speculative uses of credit. When they decided that growth was proceeding too fast and a speculative bubble or overheated economy might form, Federal Reserve authorities began raising rates in the mid-1930s. As a result, the tenuous recovery took a nosedive, and the country experienced the Crisis of 1937.

In contrast, today's massive money creation has gone into bailouts and speculation. There is no recovery, much less a tenuous one. On the contrary, Federal Reserve authorities have concentrated on fostering, even promoting speculation in the stock market, while at the same time announcing that it was keeping a careful eye on economic growth. This, of course, is apart from the obvious speculative bubble of the stock market. The Federal Reserve stands ready to begin raising the rates the moment the productive sector of the economy shows sustainable signs of life. Unfortunately, raising the rates could easily not only cause another crash, but completely stifle business, which is in bad enough shape already.

Still, perhaps the most truly astonishing thing about the recovery of the stock market in a little over a year is that Federal Reserve authorities and government officials as well as Wall Street pundits and academic economists continue to assure the public that the rapid rise in share values is not a speculative bubble. The megadollars pumped into bailing out failed gamblers and speculators and into price supports and subsidies for toxic assets are, remarkably enough, alleged to have absolutely no speculative effect. It would be interesting to find out if Mr. Bernanke, President Obama, Mr. Geithner, Mr. Paulson, and the great numbers of experts have ever read Charles Mackay's Extraordinary Popular Delusions and the Madness of Crowds (1841).

Should the Federal Reserve authorities and government policymakers ever wake up to the insanity of their approach, there is a solution ready to hand. There is a Just Third Way solution that would encourage money creation for good, productive purposes and virtually eliminate money creation for speculative purposes, consumption, and government spending. This is the "two-tiered interest rate."

In outline the concept is very simple. All money creation for speculative and other non-productive purposes must cease immediately. Just saying that, however, does nothing other than state the obvious. There is, nevertheless, a simple and most effective means by which money creation for speculation and non-productive purposes can be stopped and money creation restricted exclusively to monetizing the present value of existing and future marketable goods and services. That is to require all bills presented for discounting at a commercial bank and subsequent rediscounting at the Federal Reserve be backed by sound and properly vetted inventories of existing or future marketable goods and services — that is, constitute a "real bill," a negotiable instrument with a definable and reasonably assured present value standing behind it in which the drawer has a private property stake.

The "interest rate" on discounted and rediscounted real bills would be set at the cost of actually creating the new money. This would be the first "tier." Careful and virtually continuous scrutiny of all loans made at this tier would be built into the system. A bank's loan officer would, of course, subject such loans to the normal scrutiny. Collateral would necessarily be examined frequently as a result of using capital credit insurance to replace traditional forms of capital for loans made to finance new capital formation. For money created by discounting loans made using existing inventories of marketable goods and services, loan officers or other holders in due course would naturally confirm the existence and stated value of the inventories or contracts.

Thus, all new money would only be created in response to qualified and properly vetted industrial, commercial, and agricultural capital projects — "blue chips" — and confirmed and vetted existing inventories of marketable goods and services. All loans made out of newly created money to finance capital formation would also be required to expand direct ownership of the means of production to qualify for discounting or rediscounting.

Calling this first tier an "interest rate," however, is something of a misnomer. This is because 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.

Money creation by any means other than discounting and rediscounting real bills must be strictly prohibited — and enforced with rigor. The second "tier" interest rate would thus be the market cost of capital for existing accumulations of savings. This would be for capital projects that do not meet the qualifications for pure credit financing. This would include speculative ventures, unproven technologies, and 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, especially since (as we have seen) government borrowing is 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. (The Capitalist Manifesto, op. cit., 243-244; The New Capitalists, op. cit., 60-68.)

One of the results of this fundamental change in the way the financial system operates is that gamblers, improvident consumers, and government bureaucrats will no doubt express great outrage. This is understandable. Speculators and gamblers will have to purchase their jetons out of their own resources instead of using what Justice Brandeis called "other people's money." Consumers will have to stop living beyond their means. Government bureaucrats will suddenly become accountable to the taxpayer for every dime. It will not be possible to spend anything that is not backed up by the present value of marketable goods and services — production.

Of course, once they become used to the new state of affairs, gamblers, consumers, and even State bureaucrats will realize that the benefits that accrue to them and to society as a whole far outweigh the inconvenience associated with living within your means. Speculation, for instance, actually serves a useful purpose in the financial system — at least, as long as it is carried out using existing accumulations of savings. It is a good way to assess the risk associated with various investments, and thus in determining whether an investment is speculative, or qualifies for pure credit financing.

Consumers will be forced to consider purchases of all things on credit more carefully — but in "exchange," the prices of major items such as automobiles and houses would not be subject to the sort of speculative pressures that caused the sub-prime mortgage crisis. State bureaucrats will find themselves acting in a more responsible manner as they are forced to consider the results of their decisions on the ability to collect taxes or borrow money.

Small savers and retirees on fixed incomes should benefit more than anyone else, as this is the group that tends to purchase government bonds. The market rate of interest, being freed from manipulation by the Federal Reserve and allowed to rise to its own level, should rise rapidly at first as the federal, state, and local governments compete for a limited pool of savings. The virtues of thrift and the wise use of public credit will gradually replace present spending patterns as frivolous or non-essential programs become starved for cash.

To sum up, a two-tiered interest rate is a key monetary reform under Capital Homesteading that distinguishes "good" uses of money and credit (i.e., to finance broadly owned private sector growth and production) from "bad" uses of credit (i.e., to fuel nonproductive consumer and government debt, or speculation). The Federal Reserve's rediscount power would be available exclusively to member banks and members of the Farm Credit system for rediscounting eligible paper for feasible, ownership-expanding industrial, commercial, and agricultural projects, while open market operations would be restricted to dealing in similar instruments issued by non-member banks and other institutions, as intended in the original Federal Reserve Act of 1913.

Under this policy, credit and "new money" for Capital Homesteading, i.e., feasible business projects linked to broadened ownership (Tier 1), would be financed "interest-free" through the rediscount mechanism of the central bank, at a service charge based on the cost to the central bank of creating new money and regulating the lending institutions (0.5% or less). Credit and money for nonproductive, ownership-concentrating uses (Tier 2) would come from existing accumulations of savings ("old money"), and would be charged an interest rate determined by normal market yields on such savings. Under Capital Homesteading, local lenders would add their normal transaction fees and risk premiums for servicing capital acquisition loans, and the new loans would be collateralized by newly issued shares and newly acquired capital assets. Premiums paid to capital credit insurers and reinsurers would be pooled to spread the risk of default.


Wednesday, April 28, 2010

Own the Fed — the Program, Part X: Capital Credit Insurance as Collateral

In the previous posting in this series we explained why all money creation by the State and financial institutions, including the central bank, for non-productive purposes must stop. Expansion of bank credit for anything other than capital projects that are expected to pay for themselves within a reasonable period of time or to monetize existing inventories of marketable goods and services is illegitimate. Creating money for other purposes must be discouraged, if not prohibited outright. This should be done both by the most effective method of structuring of the system properly with adequate internal controls, as well as by passing external laws and regulations enforced by the State or appropriate regulatory agencies. The only legitimate money creation is for properly vetted and adequately collateralized capital projects intended to result in the production of marketable goods and services, or to monetize existing inventories of marketable goods and services.

Further, all capital projects financed with new money backed by the present value of future marketable goods and services must have their financing structured in a way that creates new owners rather than concentrating ownership of the means of production in fewer and fewer hands. Only in this way will the income generated by the capital after its financing has been repaid be used for consumption, not reinvestment. This will sustain aggregate effective demand, provide an adequate tax base, supply people with an adequate and secure income, and keep the economy stable.

This, of course, assumes a complete overhaul of the tax system. The goal of tax reform is twofold: 1) Simplify the tax system and make it more equitable, leaving more money in people's pockets to meet their own needs without recourse to government assistance, and 2) Return the tax system to its proper function of raising revenue to meet legitimate State expenditures, and not as a tool for social engineering. Our object in this survey, however, is monetary reform, not fiscal reform — at least directly. Important as reforming the tax system is, we will only refer to it in passing or as appropriate to make a specific point.

To return to the subject of monetary reform, we specify the present value of future marketable goods and services as the source of backing for new money used to finance new capital formation and new ownership opportunities for a good reason. By ancient rights of private property, the present value of existing marketable goods and services belongs, obviously, to existing owners of the labor, land, and capital that produced those same goods and services. Many of the troubles afflicting the economy of many countries and regions — and thus the political systems — can be traced directly to the fact that most people own little or nothing in the way of income-generating capital assets. As Kelso and Adler explained,
Under a system of private ownership of capital, the ownership may be highly concentrated in the hands of the few at one extreme, or widely diffused among the population at the other extreme; or its degree of concentration or diffusion may fall somewhere between these two extremes. Insofar as it is highly concentrated, it gives the few economic power with which they can exert undue influence on the organs and personnel of government. Insofar as it is widely diffused, it gives the people generally the economic independence they need to bulwark their political liberty. (The Capitalist Manifesto, op. cit., 94.)
Our concern at this point, however, is with new capital formation, not existing capital in which present owners have rights — and in which they must, at all costs, be secure if these reforms are to have any credibility, a measure of support, or even a modicum of acquiescence among the currently wealthy. It makes no sense to open up capital ownership to everyone, if ownership itself ceases to have any meaning. We cannot advocate diluting or abolishing the property rights of some, even for the benefit of the poorest of the poor, and expect the new property rights of the poor to be any more secure the moment we decide that they have too much, are not fit to be owners, or whatever other flimsy justification comes to mind to help us get what we want — usually power over others.

We use a present value approach in this analysis for a simple reason. Comparing the price of a capital asset with the present value of the anticipated future stream of income generated by the production of marketable goods and services is often used to decide if a capital asset is a good investment. If the "net present value" (the present value of the anticipated future stream of income less the cost of the asset) of the asset is zero or greater, then the asset is usually considered a good investment, that is, the asset is expected to generate at least enough to cover the actual cost of the asset plus the opportunity cost associated with foregoing another investment. If the net present value of the asset is less than zero, then the asset is usually considered a bad investment, that is, the asset is not expected to generate at least enough to cover the actual cost of the asset plus the opportunity cost associated with foregoing another investment.

Obviously, the net present value method of trying to determine the value of a capital asset, in common with all forecasting in all fields of human endeavor, is based on a number of semi-educated estimates and a lot of guesswork. Other factors also enter in to a decision whether to invest your time, effort, and credit into a capital project. There is, for instance, no way to know for certain whether a capital project will generate a profit or a loss. There is also the fact that some people invest in a less remunerative project for personal satisfaction and the expected intangibles derived from that particular project or endeavor.

On a more "practical" level, when deciding whether to invest in new capital, a prudent investor is extremely conservative about the anticipated stream of income from the production of marketable goods and services. Once the asset is obtained, however, the investor — if a worker-owner — tends to produce (or try to produce) at the maximum level, thereby maximizing income.

The point here, of course, is that neither the buyer nor the seller know that the asset will, in fact, be as productive as either hopes or fears. If the individuals most closely associated with the transaction cannot make this determination, then, how likely is it that a lender will be able to do so?

It is because of this uncertainty about the future that lenders require additional assurance that they will get their money back — collateral. They cannot simply rely on financial projections and present value calculations based on more or less educated guesses. Of course, we include in the category of lender both people with existing accumulations of savings to loan out (the existing supply of "loanable funds") and financial institutions that have the power to issue promissory notes and thereby create money through the expansion of bank credit (commercial and central banks).

The problem becomes how to finance the acquisition of capital by people who currently lack the wherewithal — the existing accumulations of savings that generally constitute collateral — to acquire and possess a meaningful ownership stake of income generating assets . . . without taking anything from current owners of wealth (who thereby have an effective monopoly on existing collateral) except the virtual monopoly over ownership of future, as-yet uncreated wealth.

We have already examined at great length and disproved the claim that existing accumulations of savings are necessary in order to finance new capital formation. That being so, there should be nothing standing in the way of people who lack ownership of existing accumulations of savings or capital investment from acquiring ownership of new capital assets.

Logically, that is the case. In practicable terms, however, there is what amounts to an insurmountable barrier against people without existing accumulations of savings acquiring and possessing private property in the means of production. That is the universal demand for collateral to secure any loan. Existing accumulations of savings may not be used in many cases to finance capital formation directly, but existing savings — usually in the form of corporate retained earnings — are critical in providing collateral for financing new capital formation.

Kelso and Adler addressed this problem in their second book, The New Capitalists (op. cit.), highlighting the critical nature of the universal demand for — and necessity of — collateral in securing financing for new capital formation. They proposed to replace traditional forms of collateral with capital credit insurance and reinsurance.

Kelso and Adler briefly addressed the idea of insurance in The Capitalist Manifesto as well. They introduced the concept both as a replacement for traditional forms of collateral as to protect ownership income. The latter, of course, was in answer to the all-too-common objection by elitists that ordinary people should not be subjected to the risks of ownership, or are somehow not capable of owning a meaningful private property stake in the means of production, and so on.

Evidently the risks associated with being utterly dependent on an employer who may or may not be beneficent are preferable to an ownership stake in the means of production — as long as you are not the one forced into a condition tantamount to slavery. As Hilaire Belloc pointed out in The Servile State (1912), where the small owner worries about whether his or her efforts will generate sufficient income for his or her family and dependents, the proletarian (non-owning) wage worker is suffused with the fear of "getting the sack," that is, losing his or her job.

Consequently, the proletarian necessarily gives absolute fidelity, obedience and first priority in all things, not to his or her own interests and those of the people dependent on him or her, but to whoever or whatever can best secure the worker a wage system job, be it the employer, the union, or the State. This, naturally enough, builds conflict into the system, both where the wage worker finds him- or herself in conflict between his or her own best interests, and those of the employer, union, or State, as well as in the conflicts that necessarily arise between employers, unions, and the State in the inevitable struggle that ensues as each one attempts to gain absolute control over the worker and thereby secure its own power.

To break the dependency of the propertyless worker on those who, however well intentioned, cannot have the best interests of the worker as a person at heart, Kelso and Adler proposed a type of portfolio insurance to safeguard capital income the way life insurance safeguards labor income:
Where a household is primarily dependent for support upon its ownership of capital, the primary risk to be guarded against is simply the business risk inherent in a competitive and technologically evolving economy. In large measure this risk can be minimized through investment diversification, but beyond this it should be possible to devise casualty insurance designed to protect the family income against a coincidence of business failures that would materially impair the support derived from capital holdings. (The Capitalist Manifesto, op. cit., 241.)
It is the idea of insurance as a replacement for traditional forms of collateral — that is, existing accumulations of savings — where insurance can play its most important role. This is not to say that Kelso and Adler were hostile to savings, as some might infer from the subtitle of The New Capitalists: "A Proposal to Free Economic Growth from the Slavery of Savings." Their "hostility," if you even want to call it by that misleading term, was reserved for the fixed — and erroneous — belief of Currency School adherents that new capital formation can only be financed out of existing accumulations of savings. That is, despite the fact that this dogmatic belief has been disproved time and again, Currency School adherents firmly believe that "saving" is always defined in terms of cutting current consumption, and that reductions in consumption necessarily precede investment in new capital.

On the contrary, as Moulton explained at some length in several of his books, "the formation of capital is accompanied by a virtually concurrent expansion in the production of consumption goods." (The Formation of Capital, op. cit., 47.) In English, that means periods of capital expansion are not necessarily preceded by cuts in consumption. The assumption of the Currency School — and thus the conclusions of Keynesian, Monetarist, and Austrian schools of economics to the degree that they rely on that assumption — is wrong. The historical data Moulton assembled from 1830 to 1930 in the United States show a consistent pattern of increases in capital investment preceded not by decreases, but by increases in consumption.

Moulton's observation presents us with an apparent paradox. If cuts in consumption are absolutely necessary in order to save and accumulate the wherewithal to finance new capital formation, where do investors obtain the savings necessary to finance new capital formation when consumption, far from declining, is increasing?

The answer is, "from the future." The concept of financial feasibility is predicated on the fact that a capital project is expected both to pay for itself and generate an acceptable return to the investor over its useful life. An astute investor purchases a capital asset — even out of his or her existing accumulations of savings — on the expectation that those savings will be replaced in the future as the capital becomes productive and generates a stream of income through the sale of marketable goods and services.

Future income generated by the new capital is used in part to repay the acquisition loan or replace the savings expended instead of being used for consumption. In that sense, yes, consumption is being reduced in order to finance new capital formation. The key, however, is that refraining from increasing consumption in the future in order to repay the acquisition cost of capital is fundamentally different from reducing current consumption in order to accumulate savings for the same purpose.

In the former case, the investor can maintain, even increase consumption as his or her income rises and only a portion is used for debt service payments on the capital. In the latter case, the investor necessarily reduces consumption, thereby rendering not only his or her investment less feasible, but, if all or even a determinant amount of new capital formation is financed by cutting current levels of consumption, having a detrimental effect on the entire economy.

The problem, however, is how to guarantee that capital acquisition loans will, in fact, be repaid, even when the capital project fails to generate sufficient income to justify the investment. The answer is "collateral" . . . but most people lack something — existing accumulations of savings — they can use as collateral.

Kelso and Adler's answer to this conundrum is capital credit insurance and reinsurance. Technically, insurance is coverage or security by means of a contract that binds one party to indemnify another party against a specified loss or losses in return for premiums paid. Reinsurance is "insuring the insurance." That is, reinsurance is the practice whereby an insurer (usually an insurance company) transfers a portion of the risks he or she (or it) has assumed to someone else — the "reinsurer." The legal rights of the insured — the policy holder(s) — are not affected in any way by this practice. The insurer (the original issuer of the policy) or his or her assigns remains liable to the insured for any benefits or claims.

Because the role of collateral is to insure a lender against the risk of loss, the substitution of an insurance contract for traditional forms of collateral seems obvious once it is stated. That is why Kelso and Adler expressed such bafflement that so obviously beneficial an improvement had not been adopted: "It is singular . . . that we have not to any significant degree employed an insurance system as such in dealing with the risk of entrepreneurial error." (The New Capitalists, op. cit., 57.) As Kelso and Adler explain the concept,
The existence of an insurance fund for capital acquisition financing should help to reduce underwriting costs, since the risk of failing to sell qualified stock issues within a reasonable time might either be greatly diminished or entirely eliminated. This, with a revision of the corporate income tax laws designed to discourage long-term debt financing, would not only dry up a major source of concentration but would also facilitate equity diffusion. It is important to note that such an insurance arrangement — let us call it the "Capital Diffusion Insurance Corporation" — would not directly underwrite any of the risks of the business enterprise. That is the function of the stockholder. It would only be insuring or guaranteeing the stock subscriber's or stock purchaser's obligation to pay for the stock that he purchases. (The Capitalist Manifesto, op. cit., 241.)
The concept and proposal are greatly expanded in The New Capitalists. Of most use in this survey, however, are not the technical details of the proposal. These are subject to change in any event as the concept is adapted to existing conditions and the needs of the market. What we're after here is the basic proposal, with the details to be fleshed out when specific legislation is developed, and the insurance industry designs the new products.

The proposal can be outlined very briefly. A potential owner — or, more likely, the potential owner's investment advisor (assuming that the potential owner doesn't automatically channel his or her capital credit allocation into the company for which he or she works) locates a financially feasible and properly vetted investment. The potential owner brings the investment to a commercial bank loan officer, who further scrutinizes the loan. Assuming that the investment passes muster, the loan officer passes it on to an insurance company to do an assessment of the risk and determine the risk premium. This provides an additional level of scrutiny.

Some of the requirements for an investment to qualify are 1) full payout of all earnings attributable to the shares, 2) tax deducibility of such dividends at the corporate level, 3) all dividends received subject to taxation at the ordinary rates except for any and all dividends used to make acquisition debt service payments, and 4) full voting rights attached to the shares going to the investor. Taxation of dividends at ordinary rates to the recipient for anything not used to make debt service payments and meet associated investment costs (such as the premiums on capital credit insurance policies) will be largely offset for most people by greatly increasing the personal exemption to realistic levels, eliminating most deductions except for increased deductions for education and healthcare, and a deferral for any and all qualifying assets put into a Capital Homestead Account.

Assuming everything is in order, the loan officer makes the loan and purchases an insurance policy on the loan, paid for with the risk premium by means of which financial institutions currently "self-insure" against loss. The premium for a capital credit insurance policy on a loan will, of course, be much less than the usual risk premium, however, even for a similar loan. This is because the typical risk premium on a traditional loan is determined based on the risk associated with that particular borrower, with no spreading of the risk. The premium for an insurance policy made for the same purpose, even for a loan made to the same borrower, will be much less because the risk is spread out among an entire population of loans instead of just a single individual. All loans are therefore "non-recourse" against the borrower, who thereby protects his or her other assets.

In order to make certain that people with absolutely no savings at all and a complete inability to cut consumption by any degree whatsoever can obtain capital credit to purchase income generating assets, the bank making the loan should pay the premiums on the policy, although the full cost of the premiums will be passed through to the investor once the investment starts generating dividend income. In addition, the bank will be compensated for the service it performs not by an ongoing interest charge, but a one-time service fee on each loan, taken directly out of the loan principal (discounted) to ensure that no existing accumulations of savings are needed at any step.

To make certain that all loans are backed at least 600%, all qualified loans — and no commercial bank would find it profitable to make loans other than qualified loans — will be rediscounted at the Federal Reserve, which was established for just this purpose. Thus, all loans will be backed by 1) the present value of the assets they were made to finance (100%), 2) the capital credit insurance policy (200%), which is in turn backed up by the insurance pool (300%), and the reinsurance pool (400%), not to mention 100% reserves (500%), and the full faith and credit of the federal government that by law assumes direct responsibility for all issues of the Federal Reserve (600%), which is in turn backed up by the tax base of a much sounder economy. In contrast, today's recognized money supply, M1 and M2, are backed up by government debt, as well as at present (April 2010) more than $1.2 trillion in toxic mortgage-backed securities, both of which are supported by a seriously depleted and decayed tax base in a disastrously weakened economy.

As the investment becomes profitable and begins paying dividends, the borrower will make the debt service payments, thereby redeeming his or her promissory note. The bank cancels the money, terminating the lien it took on the assets financed by the loan. If the investment fails to generate sufficient income and the loan goes into default, the capital credit insurance policy pays off. This allows the bank to cancel the loan and the amount of money created by the loan, avoiding any danger of inflation. To avoid encouraging banks to make deliberately bad loans in order to make a fee and increase profits unjustly, the full amount of a loan will not be insurable.

As an additional safeguard, no insurance or reinsurance company will be permitted to invest its insurance pool in the industry or group of industries for which it issues capital credit insurance policies.

In this way Kelso and Adler devised a way out of the Keynesian liquidity trap without the necessity of the State relying on deficit spending or for the Federal Reserve to manipulate interest rates artificially. Capital credit insurance would also make it possible for people who currently lack existing accumulations of savings to become owners of productive assets.


Tuesday, April 27, 2010

Own the Fed — the Program, Part IX: Stop Monetizing Government Deficits

In 1898, in a book with the somewhat intimidating title, Public Debts: An Essay in the Science of Finance (New York: D. Appleton and Company), Henry C. Adams warned of the dangers of permitting politicians to circumvent the taxation and appropriations process by allowing them to finance public expenditures by resorting to borrowing rather than taxation. While we are continually reassured that the gargantuan federal debt is nothing to worry about, and that the colossal amount of debt paper in foreign hands is not a cause for concern, history and common sense suggest otherwise. As Adams explained,
The great danger to self-government in the United States lies in municipal corruption, and municipal corruption is in large measure traceable to the manner in which cities have used their credit. For American readers, this reference to local government is a pertinent illustration of a most dangerous political tendency of deficit financiering. . . . The tendency of foreign borrowing is in the same direction as that of domestic borrowing. As the latter obstructs the efficiency of constitutional methods, so the former tends to destroy the full autonomy of weak states. The granting of foreign credit is a first step toward the establishment of an aggressive foreign policy, and, under certain conditions, leads inevitably to conquest and occupation. (Henry C. Adams, Public Debts, An Essay in the Science of Finance. New York: D. Appleton and Company, 1898, 25.)
If mere borrowing the existing accumulations of savings is so dangerous to individual sovereignty and human dignity, how much more so is handing over the key to the "money machine" to the politicians? That, however, is exactly what has happened in the United States and in virtually every other country on the face of the earth that subscribes to the tenets of the Currency School instead of the Banking School as the basis for its monetary and fiscal policy.

The degeneration was extremely rapid, as was only to be expected once the United States managed to cut itself loose from the inconvenient orientation toward individual sovereignty, human dignity, and the rule of law. Soon after the Federal Reserve System was established, it succumbed to political pressure. This started with the diversion of the Federal Reserve's money creation powers to finance of World War I. It continued with the establishment of the Open Market Committee in the 1930s, accelerated with the Employment Act of 1946, and has, apparently, reached its final, if inevitable end with the bailouts and subsidies to failed companies and to support prices on the stock market with purchase of mortgage-backed "toxic assets."

In consequence, perhaps no institution in history aside from organized religion has been the object of so much intrigue, hatred, and suspicion as the Federal Reserve System. Consequently, the usual demand is that the institution be abolished and that the State must take over the creation of money. This would, presumably, abolish all taxes and establish a universal reign of plenty and prosperity forever and ever.

There are a few things wrong with this solution, not the least of which is that, even if feasible, would any sane person want to give the State absolute power over the life's blood of the economy, thereby giving the State total power over every aspect of every individual's life? The answer to that, obviously, is "no." It is not, however, merely a question of how best to avoid giving the State totalitarian power. There is also the simple fact that allowing the State, which by its nature does not produce anything, the power to create money. Money being a derivative of production, it must, as Irving Fisher pointed out in The Purchasing Power of Money (1911), be linked through private property to the assets that back the money.

Because the State does not produce marketable goods and services — the assets that, ultimately (per Say's Law of Markets) stand behind money — the State, in order to back the money it issues, necessarily makes a claim on the marketable goods and services produced by others. If the State issues only a part of the money supply, it lays claim to only a portion of the wealth possessed by its citizens. If State creation of money is kept within bounds, the citizens may find it tolerable, regarding the inflationary effect of issuing money backed by future tax revenues as a more or less "hidden tax," that is, an indirect tax on their wealth.

If, however, the State creates money at too great a rate (as, historically, it has a tendency to do), the hidden tax of inflation may be too great to bear, and can even destroy the State, either through collapse of the financial system, or through the loss of sovereignty as foreign interests step in to protect their investments. Finally, if the State creates all money — a virtual impossibility, even in a socialist or communist State, given that money is properly defined as anything that can be used in settlement of a debt — the State declares itself de facto sole owner of everything in the economy. This is because the State has taken the right of disposal away from the nominal owners, and vested that right in itself. The State thereby becomes socialist, whatever it might call the arrangement, for it has thereby abolished private property by taking away a fundamental right of private property.

The other way in which a State can become socialist without either calling itself so or by assuming legal title to anything is to confiscate all income, whether through direct taxation, or through the hidden tax of inflation. The program described by Henry George in Progress and Poverty (1879) is an example of abolishing private property in land by taking all profits ("rents") of land through direct taxation, thereby abolishing the right of an owner to receive the fruits of ownership of land.

Major C. H. Douglas's social credit proposal is an example of how private property in capital instruments other than land would be abolished by indirect taxation. Douglas would require the State to issue all money, to be backed by the marketable goods and services produced each year, which Douglas asserted belongs to the collective. Private property in the "fruits of ownership" (production), a fundamental right of private property, would be abolished, and distributed by the State as a national dividend to every citizen, after deductions for necessary State expenditures.

Most modern States prefer an even more indirect method of implementing socialism and increasing their power. Paradoxically, this inevitably results in a loss of State power, which follows hard on the heels of the loss of individual sovereignty that necessarily accompanies State control of money and credit, and through those uniquely social goods, the economy as a whole.

Part of the problem, as we might expect, is reliance on the disproved, even nonsensical Keynesian "paradox of thrift." Policymakers and academic economists have allowed themselves to be persuaded that government debt is a positive good, rather than an intolerable evil. Most simply put, the Keynesian "paradox of thrift" is that it is good for individuals to save, but not good for the economy as a whole. By saving, that is, cutting consumption, individuals increase their personal wealth, but reduce aggregate demand. At the same time, the reduction in aggregate demand means that businesses are less able to prosper, or even survive. They start laying off workers and reducing the number of jobs. This reduces aggregate demand still further, causing a vicious continuing spiral downward. This causes a recession or depression to be self-perpetuating.

To be perfectly accurate, Keynes did not invent this observation. It dates back at least to the middle of the 18th century, and possibly before. What Keynes added was the idea that government "dissaving," that is, deficit spending, would cause "forced saving" through inflation. According to Keynes, forced saving transfers purchasing power from savers to investors by raising prices. A rise in prices causes consumers to spend more for the same amount of goods and services or, if income is fixed (as wages tend to be "sticky" in the short run), cut consumption while still expending the same or greater amounts of money to maintain their current standard of living.

As Moulton pointed out, the flawed approach to finance embodied in Keynesian economics means that "saving" is always defined as cutting consumption. Raising prices "forces" reductions in consumption that thus qualify as "savings." The resulting transfer of purchasing power from savers to investors provides the necessary accumulated savings (that in Keynesian economics and all other schools of economics based on the tenets of the Currency School must always precede investment) that investors require to finance new capital formation.

One problem becomes how to induce inflation and increased spending so as to bring about forced savings to the advantage of wealthy investors and to the detriment of small savers. Another problem is how to persuade businesses to use the forced savings they accumulate to invest in new capital formation, thereby creating jobs and increasing aggregate demand. As unemployment increases, aggregate demand falls, and businesses have no incentive to invest in new capital formation.

Within the framework dictated by Keynesian economics, then, the economy is ground between the upper and nether millstones of consumers who won't spend, and businesses that won't invest. Keynes, however, believed he had the answer: only the State (of course) can overcome the paradox that what is good for individuals is bad for the economy.

The main thing is to increase the money supply. "Money," of course, is always defined solely in terms of currency and demand deposits. Money, in Keynesian economics, is never defined in terms of privately issued promissory notes and other negotiable instruments by means of which more than 60% of financial transactions are currently carried out in the United States.

The first step is always to cut interest rates, regardless of the market cost of capital or what is due in justice to savers who presumably supply the financing for new capital formation. Lowering the interest rate presumably encourages businesses to borrow existing accumulations of savings in order to invest, thereby putting the savings to use. The fact that savings are rarely directly used to finance capital formation is irrelevant in Keynesian theory. All schools of economics based on the tenets of the Currency School assume as a given that existing accumulations of savings are used to finance capital formation, so all prescriptions are based on this incorrect — and extremely damaging — assumption. Bank credit, presumably based on a limited amount of existing savings, is thus a commodity, and is therefore subject to the laws of supply and demand. If you want to increase demand for the existing supply of loanable funds, you lower the price — the interest rate. If you want to decrease demand, you increase the price.

There is, however, the problem of the "liquidity trap." This is when, no matter how low interest rates go, businesses will not borrow. The demand for the existing supply of savings — "loanable funds" — becomes "infinitely elastic," although at other times it exhibits the usual degree of inelasticity. It doesn't matter how low the "price" goes, borrowers will not demand any more than they would otherwise have demanded.

Thus, under certain conditions, bank credit, for some strange reason, refuses to obey the laws of supply and demand. The possibility that this is because bank credit, not really being based on or determined by the amount of savings existing in the economy, is not a commodity does not seem to occur to policymakers and academic economists. There is also the problem that "interest," properly speaking, is not the "rent" or the "price" of money, but a lender's just share of profits (when not manipulated by the State or other authority in place of the State) adds to the problem.

The real cause of the "liquidity trap," of course, is lack of adequate collateral. The liquidity trap is not due to any real unwillingness on the part of banks to lend — making loans is how banks make profits, and it is contrary to human nature to assert that bankers do not want to make profits. The direct cause of the so-called "liquidity trap" is usually a drastic decline in the value or quality of the existing wealth that usually serves as collateral, not a general or stubborn unwillingness of banks to lend.

The Keynesian solution, however, is not to search for a replacement for the usual forms of collateral, but to inject more money in the economy. This raises the price level, causes "forced savings," and increases effective demand by inducing inflation and distributing the new money through increased welfare, job creation, or direct subsidies to business — whatever will presumably get money into the hands of people who will spend it on consumption.

A lowering of the price level is, in the Keynesian framework and other schools of economic thought based on the tenets of the Currency School, an utter disaster. The possibility that production of marketable goods and services is not due to human labor alone, and that technology is hyper-productive compared to human labor, does not enter into the discussion. "Productivity" is defined as "production per labor hour." This definition ignores or dismisses all non-human factors of production.

If, as is the case under the tenets of the Currency School, there is a fixed amount of savings in the economy, and all new capital investment can only be financed out of this existing accumulation, a reduction in the price level allows the wrong people to save. As Keynes quite logically points out, under his assumption that capital formation can only be financed out of existing accumulations of savings, there must necessarily be as few savers as possible.

These few savers (ideally only the State) must reinvest all of the income generated by capital into financing new capital formation. Only in this way can jobs be created and effective demand kept up throughout the economy. Inflation of the currency by the State presumably solves what Moulton called the "economic dilemma" (The Formation of Capital, op. cit., 26-36) by transferring savings from the wrong savers to the right savers, whether a private financial elite, or the State.

Even Irving Fisher, a monetarist, advocated "reflation," or State issues of fiat money, as the solution to the Great Depression. The argument goes something like this: 1) If people are able to obtain the same or greater quantity or quality of marketable goods and services at a lower cost than before, they can save more money. 2) If people save, however, they are cutting consumption, which reduces aggregate demand. 3) Reducing aggregate demand means that businesses will make less profit, or no profit, and go out of business. Therefore, 4) the price level must be raised by inflating the currency, and the new money distributed to people who will not save it, but spend it on consumption.

The bottom line to this reasoning is that the State necessarily maintains a large and increasing floating debt. That in the long run this means that every economy on earth will necessarily go bankrupt when the bill comes due is irrelevant. As Keynes remarked, "In the long run we are all dead." Who, then, needs to care what happens in the future?

The problem, of course, is that while Keynes's solution of always increasing the amount of State debt seemed to work to bring about a recovery from the Great Depression (although we have already seen that this so-called recovery was an illusion), somebody in the future ends up paying for what the State spends. Unfortunately for us, we are the future — the long run — that Keynes dismissed as irrelevant. However irrelevant we may have been to Keynes, though, we happen to be very relevant to ourselves. The current economic crisis suggests in the strongest terms possible that the bill has come due, and that we are, economically speaking, and in Keynesian terms, "dead."

Fortunately, however fervently Keynesians and other Currency School dévots believe that new capital formation can only be financed out of existing accumulations of savings, and that these savings can be forcibly transferred from small savers to investors or the State through inflation and maintenance of a large and increasing State debt, the truth is otherwise. As Moulton proved in The Formation of Capital (loc cit.), there is no "economic dilemma." The so-called economic dilemma that appears to require massive State debt simply does not exist.

The dilemma assumes as a given that capital formation can only be financed out of existing accumulations of savings — which we know is not the case. As Moulton pointed out, and as we have cited on more than one occasion, new capital formation has frequently been financed not out of existing accumulations of savings, but by means of the expansion of commercial bank credit, backed by the present value of existing or future marketable goods and services. (Ibid., 104.)

This is because, contrary to what economists tend to believe, whether they are Keynesians, Monetarists, or Austrians (or some variation thereon), the money supply consists of far more than M1 and M2 — that which the Federal Reserve currently defines as the "money stock." Money actually consists of anything that can be used in settlement of a debt. As we have seen, by far the larger amount of money in circulation consists not of coin, currency, or checks, but of commercial paper, merchants and bankers acceptances, bills, notes, etc.: private sector money. Private sector money is often issued by a commercial bank or other financial institution in the form of a promissory note, but can take many forms, even issued by a private company in an example of disintermediation. All of this is "money," and it all circulates. It is also the soundest money, because it is backed by the present value of existing and future marketable goods and services, not a State promise to pay out of future tax revenues.

There is thus almost no reason whatsoever that can justify a sizable State floating debt, or, frankly, a State debt of any size for anything other than the short term. This is true whether we are discussing the issue in terms of economic necessity and the source of financing for new capital formation, or political expedience when the State requires money to carry out some project.

There are two exceptions to what should be an absolute ban on State debt. The first exception, hinted at above, is purely a matter of political expedience. That is, State expenditures, even when tied absolutely to the actual amount of tax revenues, frequently do not match with tax revenues. The State needs to expend funds continuously to meet its obligations. In general, however, it cannot collect taxes continuously, even with the modern withholding system. Just as a business or an individual sometimes needs to borrow to meet a temporary shortfall in cash, the State may need to borrow in the short term to keep running until tax collections come in.

The other exception is also a matter of political expedience. When a State has already committed every available resource to its survival, as in total war, and still lacks the wherewithal to defend itself adequately, the State may justify borrowing from other States.

In neither case, however, can the State justify creating money, either directly, or through its central bank or the commercial banking system. All loans to the State, just as with loans for consumption and speculation, must come out of existing accumulations of savings. To protect the sovereignty of its citizens and ensure its own independence, the State must never make promises on which it does not have the power or ability to deliver out of existing resources or in the immediate future.

In practical terms, of course, we cannot expect the federal government (or any government, for that matter, local, regional, or national) to stop borrowing immediately. Virtually every government on the face of the earth today is a debt addict. As with any addiction, going "cold turkey" can cause more problems than the addiction, sometimes even death if withdrawal symptoms are severe enough.

As a matter of political expedience, we must permit the State to continue to borrow until financial reforms have rebuilt the tax base to the point where massive borrowing is no longer necessary, and today's massive outstanding State debt can be retired. At that point — and rough estimates suggest that restoring the tax base could take a generation — the State can stop all borrowing, except to meet temporary shortfalls in tax collections.

We cannot, however, permit the State to monetize its deficits, whether in the short term or the long term. To do so is, as we have seen, both political and economic suicide. That is why, above everything else, all money creation for State purposes, whether for political or economic ends, especially by the Federal Reserve — the central bank of the United States — must cease immediately.

To this we necessarily add that all money creation for consumption purposes, as well as for anything that is not a properly vetted and adequately collateralized capital project intended to result in the production of marketable goods and services must also cease immediately. No other course of action is in any way acceptable or even possible.


Monday, April 26, 2010

Own the Fed — the Program, Part VIII: Reform the Fed

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, it must be reformed. This is obviously plain common sense. If an institution works so as to inhibit or prevent people from realizing their fullest potential as human beings, the natural course of action is to repair or reform that institution so that it carries out its purposes adequately. Naturally enough, this raises the question as to the special role of a central bank — or any bank, for that matter.

Bank credit is the primary means by which people acquire ownership of the means of production. The need for reform of the central bank must therefore be judged by how well the central bank and the commercial banking system assist every individual in becoming a direct owner of a meaningful private property stake in income-generating assets. As should be obvious, not only is the right to be an owner (the right to property) 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.

As one authority put it, "It is precisely the object of the positive law to render the citizen virtuous." (Heinrich Rommen, The Natural Law. Indianapolis, Indiana: Liberty Fund, Inc., 1998, 48.) Thus, "The law, therefore, should favor ownership, and its policy should be to induce as many as possible of the people to become owners." (Pope Leo XIII, Rerum Novarum ("On Labor and Capital"), 1891, § 46.)

The fact that the right to private property — the right to be an owner — is absolute in every human being, of course, does not change the fact that the exercise of property must be limited. Limitations are generally imposed by the needs of the owner and other individuals, as well as the common good as a whole. As Rommen explains, continuing the passage quoted above,
It is not merely a question of maintaining order, or external peace; the law should rather act as a medium of popular education to transform those who live under common legal institutions into perfect citizens. For this very reason positive norms, determinate coercive measures, and a more exact definition of the circumstances in which the general principle shall be applied, are imperative. Thus the definition of what theft consists in is given with the lawfulness of private property. But the punishment which should follow theft, if arbitrariness is to be avoided, requires, with respect to the sentence and its execution, exact legal provisions which vary with times, cultures, and individual peoples.

Here, in connection with the positive law which is therefore always "something pertaining to reason," St. Thomas arrives at the nature of law. It has to do essentially with community life. On the other hand, it is distinguished from and contrasted with social ethics through its being directed to external order. The law wills that man conduct himself in such and such a manner; it concerns the external forum (vis directiva). It is the norm to be enforced: compulsion (vis coactiva) is proper to law, not to morality. (Rommen, The Natural Law, op. cit., 48-49.)
Unfortunately, what with today's general inability to think in any logical fashion, many people confuse what pertains to both the law and morality, with what pertains to the law alone, and to morality alone. The paradoxical belief grows up that what is legal must, ipso facto, be moral, but that what is moral must not be subjected to enforcement by the law. In reaction, those who dimly perceive that there are matters that pertain to both law and morality begin asserting that the State has the job of enforcing all that is moral, whether or not the matter is truly enforceable by human law, or even properly comes under human law at all.

The "trick" (if you insist on so terming it) is to balance what people are willing to accept at any stage of development of their culture or civilization, with what is necessary for the full development as human persons within that society. Thus, at various times in history, moral authorities have "allowed" such things as polygamy, slavery, capital punishment, capitalism, divorce, war, and the wage system not because such things are inherently good or the proper way to organize the social order, but because of the "hardness of people's hearts" and the fact that society was not yet ready to move to something higher.

There are even instances in which society must tolerate something that is objectively evil in and of itself, if the unintended result of attempting to abolish it would result in the destruction of the social order. Where something objectively evil exists in society and is widely accepted, the proper response is not to coerce people by means of the law to stop the evil act or acts, but to organize with an eye toward the common good, changing our institutional environment and people's attitudes and beliefs to conform more closely with the demands of the natural law.

Consequently, and consistent with the principles of the Just Third Way, we believe that there are seven 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:
• Immediate cessation of monetizing government deficits.

• Establishment of capital credit insurance and reinsurance to serve as collateral.

• Establishment of a "two tier" interest rate to separate "good" (i.e., productive) credit from "bad" credit for consumption, speculation, and government spending.

• A 100% reserve requirement to ensure full asset backing of the currency.

• Restoration of the autonomy of regional Federal Reserve banks.

• Extend the term of qualified paper discountable at the central bank to allow for financing of long-term capital projects.

• Direct ownership of the Federal Reserve by every citizen.
Obviously the framework within which such reforms are required or even comprehended is substantially different from the general paradigm within which most policymakers and academic economists currently operate. Since the American Civil War, there has been a fundamental shift in our perception of the State and the role the State is supposed to fill. From a country in which "society governs itself for itself" (Alexis de Tocqueville, ("The Principle of the Sovereignty of the People of America," Democracy in America, Volume I), the United States has become, by and large and by degrees, a country in which "the supreme power, the determining efficacy in matters political, resides in the people — not necessarily or commonly in the whole people, in the numerical majority, but in a chosen people, a picked and selected people." (Walter Bagehot, The English Constitution. Portland, Oregon: Sussex Academic Press, 1997, 17.) Bagehot's emphasis on the word "chosen" was clearly intended to denote some form of election by a divinity, e.g., the Jews described as the "Chosen People," not by the electorate.

What confuses many people is that the outward forms of political democracy have been preserved, even extended to great numbers and classes of people, as well as into areas in which "politics" in the narrow sense does not even belong. As a case in point, we need merely mention the oddity of asserting same-sex marriage as a civil right. On the contrary, marriage is a domestic institution, not a civil institution. Marriage is thus a domestic, not a civil right. The State has no competence to define marriage, and no power other than to protect the civil rights of persons in a marriage and the common good as a whole — not to define the institution itself. Asserting that the State does, in fact, have the power to "re-edit the dictionary" with respect to marriage or anything else is to give the State totalitarian control over the whole of society and over every person. Every person and every thing becomes a "mere creature of the State." (Pierce v. Society of Sisters of the Holy Names of Jesus and Mary, 268 U.S. 510 (1925).)

The only protection ordinary people have against the intrusion of the State into areas beyond the competence of the State are the inherent rights of each human person embedded in the ordinary laws of society. These, however, have become effectively meaningless with the economic disenfranchisement of ordinary people. Sovereignty of the people is replaced by the sovereignty of a presumed "chosen" elite. Most often and most effectively, this is through the establishment of what Pope Pius XI termed a "despotic economic dictatorship." This "is consolidated in the hands of a few, who often are not owners but only the trustees and managing directors of invested funds which they administer according to their own arbitrary will and pleasure." (Quadragesimo Anno, op. cit., § 105.)

The establishment and maintenance of an economic dictatorship has given rise to a political despotism that people of previous generations could not even imagine. Largely this has been because the presumably divine statutes that govern the regulation and creation of money and credit under the tenets of the Currency School have obscured the loss of liberty, or rendered it more or less palatable as a tradeoff to gain material security or other presumed or anticipated advantages. The ownership-concentrating and property-destroying operation of the money, credit, and banking systems under these assumptions are taken as a given.

The political system, in tacit acknowledgment of Daniel Webster's dictum that "power naturally and necessarily follows property," has been modified imperceptibly over the years, keeping pace with popular economic disenfranchisement. The political system, while leaders necessarily pay lip service to popular sovereignty, has become increasingly despotic, matching the economic despotism that results from unquestioning acceptance of flawed principles of economics and finance.

The outward forms have been preserved, but the substance, once ordinary people have been stripped of the means of maintaining themselves through direct ownership of the means of production, is gone, seemingly forever. Even an otherwise astute analyst such as Albert Venn Dicey could be fooled by the maintenance of outward forms and the removal of the substance. Dicey failed to take into account the effect that loss of economic power inevitably has on the effectiveness of political power. As he commented,
Where the right to individual freedom is a result deduced from the principles of the constitution, the idea readily occurs that the right is capable of being suspended or taken away. Where, on the other hand, the right to individual freedom is part of the constitution because it is inherent in the ordinary law of the land, the right is one which can hardly be destroyed without a thorough revolution in the institutions and manners of the nation. (A. V. Dicey, Introduction to the Study of the Law of the Constitution. Indianapolis, Indiana: Liberty Fund, Inc., 1982, 119-120.)
Dicey was absolutely correct that it would take a "thorough revolution in the institutions and manners of the nation" to effect so profound a change as the shift from an orientation on natural law ("the rule of law"), to legal positivism, in which the law becomes what the judges or anyone else with enough power says it is. Nevertheless, although Dicey taught at the London School of Economics, he did not take into account the devastating effect that the loss of private property in the means of production has on ordinary people in an economy, and the degree to which political power relies on economic power.

Political democracy simply cannot survive unless built on a solid foundation of economic democracy. It is no coincidence that the rapid spread of positivism in all its forms as the prevalent philosophy always accompanies the decay and eventual disappearance of private property in the means of production for the great mass of people. Thus, economic disenfranchisement effects the "thorough revolution" in our "institutions and manners" that Dicey declared must occur before there could be a loss of liberty and the overturning of the rule of law.

Nor is this changed in any way by the delusion that wages and fixed benefits, whether guaranteed by the State or by some private agency, can secure economic (and thus political) power to the ordinary wage earner. Wages secure dependency — slavery — not sovereignty, as modern economic and political theories make clear, especially those of Keynes. Our inalienable — inherent — rights to life, liberty, property and the acquisition and development of virtue secure our sovereignty and protect our human dignity, not State fiat, welfare, high fixed wages and benefits, or increased external regulation designed to impose desired results rather than protect equality of opportunity and a level playing field.

Loss of personal sovereignty and lack of respect for essential human dignity are principally due to the presumed inexorable necessity of only financing capital formation — and thus inhibiting or preventing widespread direct ownership of the means of production — out of existing accumulations of savings. The New Deal, President Obama's "change," President Clinton and Prime Minister Blair's "Third Way," even modern capitalism and socialism, are all efforts to accommodate both our political systems and the financial markets to the presumed reality of the necessity of existing accumulations of savings to finance capital formation. This is what Kelso and Adler accurately termed, "the slavery of savings."

Thus we have a supreme irony. The Federal Reserve was established "to furnish an elastic currency, to afford means of rediscounting commercial paper, [and] to establish a more effective supervision of banking in the Unites States," or, briefly, to supplement the amount of savings in the economy plus what the commercial banks could safely create given existing reserves. With the changeover from a predominantly asset-backed currency to a predominantly debt-backed currency as a result of the New Deal — we specify "currency" because private sector money, at least 60% of the money supply, is necessarily asset-backed, or it would not be acceptable in the channels of commerce — the need to restore asset-backing becomes critical. The currency must be 100% asset-backed, not 60%-and-falling asset-backed.

Clearly we need to reform our "institutions and manners" to conform more closely to the natural moral law than they do at present. The specific techniques to achieve this end are not, however, the point of this survey. William Ferree outlines the proper and most effective approach to reforming our institutions and manner in Introduction to Social Justice (1948), which is highly recommended for study and review before starting to organize with others to carry out such a "thorough revolution." As important as the techniques of social justice are and remain, however, our concern at this point is with the specific reforms of institutions and manners to be sought, not how to achieve the desired end.

In general, the first step is to reorient people away from a misplaced faith in the State, and back to the use of reason in applying the precepts of the natural law. That is, people must relearn to use basic common sense, especially with respect to the structuring of the economic order. The law, as people of sense have known for millennia, is found in reason alone. If something that the State (or, more usually, the State's agents) or some other authority declares contradicts something established by reason, there is a good chance that the declaration is false.

Thus, the continued assertion that only existing accumulations of savings can be used to finance capital formation — disproved many times through history and every day in the financial markets — must be jettisoned. There must be a restoration of Say's Law of Markets and the real bills doctrine that, taken together, are integral to the understanding of money as anything that is or can be used in settlement of a debt. In short, there must be a reorientation back to sound banking theory, in which a bank is understood as a financial institution not only takes deposits and makes loans, but issues promissory notes — "money" — and money itself is clearly understood as a derivative of production. These are the basic principle of the Banking School.

Consequently, there must be a reorientation away from the tenets of the Currency School, in which "money" is understood as accumulated savings — but only in the form so-defined by the State, which thereby claims dominion over the whole of economic life, an "economic dictatorship" to match the growth of State absolutism. As Keynes declared, both illustrating the shift from rule of law to rule of will and the insidious, even deadly reliance on accumulated savings as the only source of capital financing,
The Age of Chartalist or State Money was reached when the State claimed the right to declare what thing should answer as money to the current money-of-account — when it claimed the right not only to enforce the dictionary but also to write the dictionary. To-day all civilised money is, beyond the possibility of dispute, chartalist. (Keynes, A Treatise on Money, Volume I, The Pure Theory of Money. New York: Harcourt, Brace and Company, 1930, 5.)
We need merely draw the attention of the reader to the claim that the State has the power "to write the dictionary" to demonstrate not only the terrifying dangers inherent in adherence to the tenets of the Currency School, but to show the colossal arrogance embodied in the assertion that such a claim is "beyond the possibility of dispute"! Before the current series of bailouts and subsidies of companies "too big to fail" began, direct State control over the economy has in little over a century and a half gone from an insignificant proportion of less than 10% reported in the 1830s (see George Tucker, loc. cit.), to just under 40% in 2008 (see posting number III in this series). The current spate of bailouts and expansion of government further into the economy can reasonably be expected to expand this percentage and, with it, totalitarian control over the means by which people are permitted to exist.

The Federal Reserve was, in fact, never intended to control the money supply at all, but to regulate the currency and the banking system. Chiefly this was to ensure an adequate supply of credit for industry, commerce, and agriculture, while at the same time breaking the virtual monopoly of Wall Street over the supply of money and credit. The clear intent of the framers of the Federal Reserve Act of 1913 was that the private sector would continue to supply its own liquidity in the form of bills drawn on industrial, commercial, and agricultural assets, discounting them at commercial banks when necessary for a more liquid form of money.

If the commercial banks required more liquidity, the Federal Reserve would be there to rediscount such "qualified paper," thereby ensuring that there was always enough liquidity in the system, never too much, never an insufficiency. This would avoid the twin evils of inflation and deflation. The Federal Reserve was to supplement and regulate, not control, the money supply, which was presumed to be chiefly the purview of the private sector, over which the central bank would keep watch to prevent the kind of monopoly power over money and credit that caused the Panic of 1907. This had the potential not only to break up the concentration of control over money and credit that led to the Panic (see U.S. Congressional House Committee on Banking and Currency, Report of the Committee Appointed Pursuant to House Resolutions 429 and 504 to Investigate the Concentration of Control of Money and Credit, February 28, 1913. Washington, DC: U.S. Government Printing Office, 1913), but also free the United States forever from the "slavery of savings."

Thus, there is a desperate need to restore banking in general, and the Federal Reserve in particular to filling the special role that banks necessarily play in any economy that isn't permanently stagnant. By reorienting the economy along the lines of the Just Third Way, that is, in a manner consistent with the needs of the common good and the demands of human dignity, we can lower barriers and restore democratic access to bank credit, the chief means by which people acquire and possess private property in the means of production.

This requires that the commercial banking system and the operation of the central bank conform as fully as possible to the natural moral law — that is, a properly regulated financial system, and a money supply backed by the present value of existing and future marketable goods and services, not government debt. It also means that the central bank and the commercial banking system must operate in such a manner as to encourage widespread direct ownership of the means of production.

The obvious place to start, then, is to begin dismantling the apparatus that the federal government has imposed on the financial system and which has resulted in a phenomenal growth in State power as well as the concentration of ownership of the means of production in the private sector. That means the immediate cessation of the ability of the federal government to have the Federal Reserve monetize its deficits by buying and selling government debt paper through open market operations.