As we've mentioned a couple of times in the weekly News from the Network, we're working on an updating of Capital Homesteading for Every Citizen, which we published in 2004 before one or two things happened. Part of the task involves revising and adding to the "Just Third Way Glossary" that proved to be such an important part of the book. For today's posting, we thought we'd present some of the revised and new entries to the Glossary.
Acceptance. In financial terms, an "acceptance" is a negotiable instrument, such as a bill of exchange, mortgage, or bill of credit, that is accepted in settlement of a debt. Anything accepted in settlement of a debt is considered "money." When the offer and acceptance of an instrument is between non-bank private parties, the instrument is known as a "merchants" or "trade" acceptance, and is to all intents and purposes, privately issued money. When the offer and acceptance of an instrument is between a non-bank private party and a bank of issue, or between two banks of issue, the instrument is known as a "bankers acceptance."
Anticipation Note. See "Bill of Credit."
Bank of Deposit. A bank of deposit is defined as a financial institution that takes deposits and makes loans. It is limited in the amount of loans it can make by the amount of its capitalization and deposits. A bank of deposit cannot create money. The most common types of bank of deposit are credit unions, savings and loans, and investment banks.
Bank of Issue. A bank of issue (also known as a "bank of circulation") is defined as a financial institution that takes deposits, makes loans, and issues promissory notes. A bank of issue can create money by "accepting" and "discounting" or "rediscounting" private sector "bills of exchange" or government "bills of credit," for which the bank issues a promissory note. The promissory note is used to back demand deposits or (rarely nowadays) smaller promissory notes known as "banknotes." When a bank of issue accepts private sector bills of exchange, the money supply is asset-backed and represents the present value of future marketable goods and services conveyed by discounting or rediscounting bills of exchange. When a bank of issue accepts government bills of credit, the money supply is debt-backed and represents the present value of anticipated future tax collections by the State conveyed by purchasing the State's "anticipation notes," as bills of credit are also known. The most common types of bank of issue are commercial and mercantile banks. A central bank is a special type of bank of issue, possibly best understood as "a bank of issue for banks of issue," intended primarily to provide rediscounting accommodation for member commercial banks.
Bank, Central. A "bank of issue for banks of issue." A central bank functions as a bank of issue for a region's commercial banks, usually being the only financial institution permitted to "monetize" assets for circulation as legal tender currency. A central bank differs from other banks of issue in that it accepts negotiable instruments that have already been made or issued by other banks and financial institutions, businesses, or individuals. A central bank accepts such assets by rediscounting the instruments issued by member banks, or purchasing the instruments issued by non-member banks, businesses or individuals on the open market. A central bank pays for the instruments by printing currency, striking coin, or creating demand deposits denominated in units of the currency. This money is cancelled or retired when the original issuer of the instrument redeems the instrument. A central bank regulates the creation of money and credit, and sets interest rate policy, provides member banks with reserves on an emergency basis, and oversees clearinghouse operations. If operated properly, a central bank thereby establishes a uniform and stable asset-backed currency that has the capacity to expand and contract directly with the needs of private sector industry, commerce, and agriculture.
Bank, Commercial. Also known as a "Mercantile Bank." A financial institution that takes deposits, makes loans and issues promissory notes — a "bank of issue" — to facilitate commercial transactions. A commercial bank creates money for carrying on a society's economic transactions by accepting bills of exchange for discounting. If permitted by law, a commercial bank may also function as a savings bank ("bank of deposit") offering personal financial services to individuals.
Bank, Investment. A financial institution that takes deposits and makes loans to facilitate the buying and selling of securities, e.g., shares of company stock and corporate debt instruments. The special function of an investment bank is to intermediate between "savers" — usually brokers handling individual, corporate, or institutional accounts (past savers), and banks of issue that have created money on behalf of their customers by accepting bills of exchange (future savers) — and the issuers or holders in due course of primary or secondary issues of securities. An investment bank thus serves as a middleman between the primary or original issuer of a security, and the ultimate secondary purchaser.
Bank. There are two basic types of institutions known as "banks." These are (1) Banks of Deposit, and (2) Banks of Issue. A bank of deposit is defined as a financial institution that takes deposits and makes loans. A bank of issue (also known as a "bank of circulation") is defined as a financial institution that takes deposits, makes loans, and issues promissory notes. A Central Bank is a special type of bank of issue intended to function as a "bank of issue for banks of issue."
Bill of Credit. A "bill of credit" is a special "constitutional" type of bill of exchange issued ("emitted") by a government. Also known as an "anticipation note" (from "anticipated tax revenues"), a bill of credit is not backed by assets, per se, but by the "faith and credit" of the government, that is, the ability of the government to redeem the bill of credit out of future tax revenues.
Bill of Exchange. A bill of exchange is a private sector negotiable instrument backed by the general creditworthiness of the "drawer" or issuer. The present value of the bill is thus based on the present value of the anticipated future marketable goods and services the drawer expects to produce and sell, thereby generating the means to redeem the bill upon maturity. Assuming an honestly run and properly regulated banking system with enforcement of adequate internal controls (especially separation of commercial from investment banking — see "Glass-Steagall"), the amount of bills of exchange drawn is necessarily limited by the present value of potential financially feasible capital projects in the economy. Bills of exchange should be carefully distinguished from mortgages and bills of credit.
Chicago Plan. A proposal from the 1930s to implement a 100% reserve requirement (i.e., full asset backing behind all bank loans) as a means of addressing the financial chaos resulting from speculative loans that resulted in the stock market crash of 1929. The weakness of the Chicago Plan was that it did not take into account Say's Law of Markets as applied in the real bills doctrine. Consequently, the special function of commercial banks and the Federal Reserve in creating money by accepting bills of exchange for discounting and rediscounting was ignored. The proposal was to transform all commercial banks and the Federal Reserve into purely depository institutions — banks of deposit — and back the whole of the money supply with government debt. By prohibiting money creation by discounting and rediscounting private sector bills of exchange, the Chicago Plan would have put the U.S. economy under the control of the federal government, a problem that Henry Simons, who developed the Plan, was not able to reconcile with his anti-monopoly stand.
Discount Rate. The percentage by which a central bank reduces the amount of cash printed or demand deposit created to purchase qualified securities from member banks and financial institutions. While often erroneously construed as an interest rate, under binary economic policy, this rate takes the form of a service fee, estimated at 0.5%, to cover all central banking and regulatory costs of monetizing Capital Homesteading loans made by commercial banks and other qualified financial institutions for broadening the ownership of new capital. The discount rate is a recognition of the time value of money, and should reflect the present value of the face amount of the instrument due on maturity and the risk associated with the possibility that the drawer of the bill will not redeem the bill on maturity. In binary monetary policy, the risk premium is separated from the time value of money and used to purchase capital credit insurance to compensate the holder in due course of the instrument in the event of default.
Discounting. A bill of exchange is always offered and accepted in commerce at the present value of the future redemption amount denominated on the face of the bill. Because the present value of a future sum is almost always less than the face value of the instrument, the initial process of offering and accepting a bill of exchange is called "discounting." For example, on a $10,000 loan discounted at 0.5%, the lender would give the borrower $9,950 ($10,000-$50) in cash. The "discount rate" is not an interest charge, but a recognition of the time value of money as well as the risk that the bill will not be redeemed on maturity. All subsequent offers and acceptance of the same bill are called "rediscounting." The initial discounting of a bill creates new money, while rediscounting transfers existing money. A bill of exchange that has a present value in excess of the face amount is said to pass at a "premium," but the offer and acceptance is still called discounting and rediscounting. While central banks may discount bills directly from the public, the primary function of a central bank is to accept rediscounts from member banks, supplemented with open market operations in the securities issued by non-member banks, private businesses and individuals. In all cases, a central bank purchases qualified loans by printing currency or creating demand deposits.
Glass-Steagall Act. There are two acts known as "Glass-Steagall," after the sponsors, Senator Carter Glass of Virginia, and Senator Henry Steagall of Alabama. The first is the Banking Act of 1932, which permitted the Federal Reserve to accept government bills of credit intermediated by special brokers instead of member commercial banks, thereby streamlining the process of monetizing government deficits. The second is the Banking Act of 1933, Pub.L. 73-66, 48 Stat. 162 (June 16, 1933) that, among other reforms, established the FDIC and separated commercial and investment banking as a systemic or internal control to prevent speculation and conflicts of interest. The partial repeal of the 1933 Glass-Steagall in the early 1980s (The Depository Institutions Deregulation and Monetary Control Act of 1980 and the Garn-St. Germain Depository Institutions Act of 1982) led to the savings and loan crisis of the late 1980s and early 1990s and permitted mergers that led to the formation of financial institutions considered "too big to fail." The full repeal of Glass-Steagall in 1999 in response to the unification of the financial services industry in Europe due to the introduction of the Euro on January 1, 1999 abolished systemic internal controls in the U.S. financial services industry and led directly to the financial crisis of 2007 and the subsequent economic downturn.
Mortgage. A mortgage is a private sector negotiable instrument backed by the present value of existing marketable goods and services owned by the "drawer" or issuer. The present value of the mortgage is thus based on the current value of the goods and services on which the mortgage is drawn. In the event a drawer of a mortgage fails to redeem the mortgage on maturity, the holder in due course of the mortgage becomes the owner of the goods and services. The home or real estate mortgage is most familiar, but not the most common type of mortgage, which is widely used in commerce, usually in the form of a secured debenture.
Real Bills Doctrine. An application of "Say's Law of Markets." The real bills doctrine is that, everything else being equal, as long as the present value of the bills of exchange discounted in the economy in aggregate equals the present value of future marketable goods and services there will be neither inflation nor deflation, but a uniform, stable, and elastic money supply that exactly meets the needs of the economy.
Reserves. Cash or cash equivalents (currently usually government securities) that a commercial bank has on hand to cover transactions demand for cash on deposit, and to satisfy the demand for convertibility of the bank's obligations into legal tender. It is important to note that reserves do not back the bank's obligations. The bank's obligations (promissory notes and demand deposits) are backed by the present value of the bank's capitalization, deposits, and accepted bills of exchange.