Last week we looked at what a central bank is, and what it’s supposed to do. Today we’re going to take a short look at how the whole reason for having a central bank in the first place has been diverted to serve political interests. No wonder some people say the Federal Reserve ought to be abolished and the government just print the money it needs directly instead of fattening the purses of brokers whose only purpose is to turn the primary issuances that the Federal Reserve isn’t permitted to deal in, into secondary issuances by holding them for a microsecond.
|"What this country needs is a good, five-cent nickel."|
Let’s begin by taking a quick peek at a government study. Back in December of 1976 (you know, in Ancient Times . . . cue "Jerusalem"), the House Subcommittee on Domestic Monetary Policy, published a study entitled, “The Impact of the Federal Reserve System’s Monetary Policy on the Nation’s Economy.” The study recommended a 4% to 6% growth in the M2 money supply (currency plus demand deposits and selected time deposits) “as a foundation for sustained economic growth.” Six months later the Federal Reserve’s growth target was set at 4.5% to 6.5%.
|"Are you sure we didn't get the whole thing backwards?"|
Now for the kicker. Observe that the study makes an important — and erroneous — assumption with respect to how the Federal Reserve was intended to operate: that money is first created, then spent or loaned into the economy. There is no possibility under this assumption of distinguishing in advance whether money creation is for productive projects or for mere spending.
Thus, creating money in this fashion is purely inflationary, as it is used to purchase existing goods, whether consumer or capital, creating upward pressure on the price level. Further, all money created in this fashion is necessarily backed solely by debt, not hard assets.
In contrast, the non-inflationary way of creating money is first to identify and evaluate an investment to see if it would be suitable, then to create money backed not by debt, but by the present value of the investment being financed. This is inherently non-inflationary as well as non-deflationary.
This is because creating all new money through the institution of private property by linking it directly to the present value of existing and future marketable goods and services ensures as far as humanly possible that the money supply equals what the money will buy. Thus, where the assumption of the House Subcommittee was that first money is created and then spent, a sound monetary system requires that money creation is the second step, right after identifying and evaluating the present value of an existing or future marketable good or service.
|Wrong Uncle Miltie ... but more credible.|
The House Subcommittee’s report — which reflected the heavy influence of Milton Friedman on U.S. monetary policy — shares one thing in common with those who advocate expanding the money supply for “Welfare State” purposes. The new money supply, under either conservative or liberal game plans, is pumped indiscriminately into the economy through the economy’s existing “credit irrigation” system.
True, part of our present credit system channels funds into expanding market-oriented production (assuming that speculative gains on the stock market don’t suck away funds required for capital expansion), but a significant part of the system channels money into nonproductive, resource-wasting, and non-market-oriented purposes . . . such as stock market speculation. Thus, quality control (in terms of sharply distinguishing between the “productive” versus “non-productive” uses of credit) has not been factored into the strategies of either side of the debate on monetary policy.
Conservatives, of course, would favor closing the non-market-oriented “leaks” in the present irrigation system. Unfortunately, they also ignore the fact that this would channel even more credit into ownership-concentrating modes of capital creation. This would increase the political pressure for redistribution that caused the “leaks” in the first place. While favoring private property, monetarists like Friedman offer no solutions to the dangers inherent in a society where the majority of voters own no capital — and who are therefore willing to vote for politicians who will increase spending and erode the ownership base of the economy even further, to the point of no-return, if that’s what it takes.
|A piece of the action.|
Under a comprehensive, long-range national Capital Homesteading strategy, however, the key to growth without inflation is the highly selective use of the Federal Reserve’s discount powers and control over credit costs. Ideally, the Federal Reserve, in controlling and channeling monetary growth, would differentiate sharply between interest rates on already accumulated savings (i.e., “other people’s money”) and credit costs on newly created central bank credit for stimulating private sector investment growth among new owners (“pure credit”).
What is missing is a refinement in the present irrigation system — a two-tiered credit policy that would permit increases in the money supply to be channeled more selectively into new private sector plants, equipment, and advanced technology, but through routes that gradually and systematically create new capital owners, thus reducing the pressures for forceful redistribution.
This actually quite feasible, and surprisingly easy to accomplish — once you know the principles. We’ll look at how to move from a debt-backed to an asset-backed currency tomorrow. It’s astonishing how pain-free the process can be . . . for everyone except politicians and Wall Street speculators. . . .