Continuing our practice of using answers to some questions as blog postings, we recently got a question about how widespread capital ownership is financed. Specifically, is money given to people so that they can become owners by purchasing existing assets or is there a fundamentally different way. As our questioner questioned,
I need some help. Do I understand correctly that in the figures on the spreadsheet $10,000.00 is added (borrowed?) to the child’s ownership account? If so, please explain how this works. Also, is it appropriate to use figures based on a 15% annual return? It would help me understand it if you can send me the answers in an email. If you prefer, however, you can call me. Thanks.
First off, the spreadsheet to which the questioner refers is “Projected Citizen Wealth Accumulations Under the Economic Democracy Act,” which needs a bit of updating, and is very condensed, as we didn’t think too may people want to read a spreadsheet with nearly 1,000 cells with numbers in them. . . . Anyway,
With respect to the additions to a child’s — or anyone else’s — account, nothing is or even can be done until and unless a financially feasible investment is identified. Especially in the early stages of the program this will be primarily newly issued growth shares with a full dividend payout requirement and voting rights. In theory, any shares, newly issued or existing, that have the full dividend payout requirement and full voting rights would qualify, but in my opinion, there won’t be too many existing shares that shift over to qualified shares in the beginning.
|"YAY! We're off to select my quarterly investments!"
In practice what will happen is that the child’s parents or guardian will go to a local bank or other qualified financial institution where the child has opened an Economic Democracy Account (if we recall correctly the new name for it; we have “Capital Homestead Account” embedded in my brain and it’s hard to root out). On consultation with the bank officials and with the concurrence of the capital credit insurance provider, the child’s parents or guardian will make a selection of shares to purchase, presumably in the full amount of $10,000.
|"Then we get ice cream!" (Strongly recommended.)
Note that up to this point no new money has been created or credit extended. Instead, with the help of the bank officials, the parents or guardian prepare an offer to purchase the selected shares called a bill of exchange. The bank officials (already knowing that the proposed loan should be feasible since they helped select the shares that are probably already approved by the insurer) accept the bill (turning it into a “bankers acceptance”) and issue a promissory note obliging the child’s account (not the child) to repay $10,000 plus a discount out of the future dividends to be received.
The moment the child’s parents or guardian signs the promissory note on the child’s behalf, money has been created, and can (actually legally must) be used to purchase the selected shares, which are then deposited into the child’s account, probably into an escrow subaccount, since the shares cannot be sold by the account holder until they are paid for.
|"I'm paying for my own college (and ice cream)."
As the dividends are received by the account, they are passed through to the bank in payment of the loan. Once the loan principal and the discount (totaling the face amount of the promissory note) are paid in full, the shares are released from the escrow subaccount and future dividends on the shares are paid out to the child’s parents or guardian.
The bank cancels the amount of the payment received by the bank representing the amount of money previously created to purchase the shares, thereby removing the now unbacked money from circulation, preventing inflation. The bank books the amount of payment received that represents the discount as revenue, and out of it meets its costs and realizes a profit. If a central bank is in the picture, the exact same process is repeated between the commercial bank and the central bank as between the borrower and the commercial bank; it doesn’t matter how long the transaction chain is as long as it is unbroken.
The discount is set by the market, based on the present value of the shares being purchased. If the discount is not enough to cover the bank’s costs and a just profit, the bank should not make the loan. The bank must not create the money for the discount, as that would result in unbacked money as the bank does not cancel the amount it receives in payment of the discount.
|Growth without inflation is a whole new ball game.
The only new money created is to purchase the shares, not pay any expenses. Thus, if $10,000 of shares are to be purchased, $10,000 of new money is created, but the face of the promissory note includes an added-on discount. Assuming a market-determined discount of 3%, the bank would create $10,000 of new money, while the child’s parents or guardian would sign a promissory note obliging the child’s account to pay the bank $10,309.28 ($10,000 + (1 - .03) x $10,000).
With respect to the 15% ROI, we believe it to be extremely conservative. Keep in mind that dividends would be tax deductible under the Economic Democracy Act, and the average corporate tax rate in the United States is around 28% at present. A rule of thumb for business in the United States is a post-tax ROI (Return On Investment) of 15-30% for small to mid-size, non-publicly traded companies.
(Don’t bother with using the ROI for listed companies, as these are based on Wall Street investor returns, which historically are between 9-12% and are a combination of capital gains, limited dividend payouts, and speculation, none of which are valid for the EDA estimates and projections.)
Assuming the lower post-tax ROI of 15%, a more realistic figure for the EDA projections would be a pre-tax ROI of 20.83% (15%/(1-.28)), but we stuck with the post-tax ROI to be conservative.
We hope that answers your questions.