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Wednesday, July 3, 2024

Central Bank Funding, II: Traditional Solutions to the Twin Threats

Today’s posting is the second half of “Central Bank Funding of Economic Growth and Economic Justice Through Expanded Capital Ownership” By Norman A. Bailey, Ph.D., presented at the Capital Ownership Group Conference on Globalization, Four Points Sheraton Hotel, Washington, D.C., October 9-11, 2002.

The first half of this article,“The Twin Threats,” can be found here.


Since the mid-nineteenth century, in the face of radical movements spawned by gross income disparities and monopolistic capital ownership, society’s response has taken the form of either “social ownership” (socialism or communism) of the means of production or various forms of coercive income redistribution in order to provide those without capital ownership with at least a minimal revenue stream beyond their actual contribution to the value of production. Redistribution has been supplemented in the more prosperous countries by a vast expansion of credit for the consumption of perishable goods and housing to be paid for from the revenue stream assured by the welfare statist programs mentioned. In the United States, this has reached truly huge proportions with the housing parastatals Fannie Mae and Freddie Mac issuing debt in quantities rivaling that of the federal government and way beyond that of state, local, industrial or commercial debt.


In the international arena, the traditional way of dealing with financial crises, which always includes the collapse of commercial credit, involves lending by governments and international financial institutions (IFIs), especially the International Monetary Fund, to repay other lenders or in the ultimate idiocy, themselves, under conditions of strict conditionality, which if adhered to make the underlying conditions worse, by making economic recovery more difficult. More recently, support has developed for the adoption of some form of international bankruptcy status, which would guarantee the total cessation of commercial credit availability to the countries availing themselves of it and make them completely dependent on official financing sources, whether governmental or international.

None of these traditional methods of addressing the twin threats works, because the underlying negative conditions are not addressed by them. In the case of socialism and communism the oligopolistic owners of productive capital are substituted by the monopolistic state, which makes a bad situation infinitely worse with utterly disastrous results. The welfare state is at best a palliative which reduces the pain as the patient gets steadily (if sometimes slowly) worse. Over-indebtedness for the acquisition of consumer goods and housing adds to the problem and makes an eventual solution more difficult. Internationally, lending more money to insolvent countries simply leads to increased indebtedness, often under conditions which make addressing the underlying problems even more difficult.

Central Bank Financing of Expanded Capital Ownership


A full discussion of central banking is impossible in the compass of an article. For our purposes it suffices to say that a central bank can purchase any asset with the currency and credit it issues. Over the history of central banking, starting in the late seventeenth century, central banks have issued currency and credit on the basis of purchases of precious metals, other currencies, commercial paper (industrial, commercial, agricultural or export) and other assets. The fact that at present most central banks, including the Federal Reserve System in the United States, fund their currency and credit issue primarily through the purchase of government securities (their own or other governments’) is simply part of the vicious circle mentioned above — the monetary system is based on the government debt, a logical absurdity made necessary by the requirements of the welfare state. The total bankruptcy of this system was amusingly demonstrated when at the end of 1999, terrified by the specter of hordes of depositors demanding their money at banks paralyzed by the (as it turned out non-existent) Y2K computer problem, the Federal Reserve greatly increased the money supply, and since it had run out of government obligations to buy it bought huge quantities of Fannie Mae and Freddie Mac paper instead. Perhaps a better metaphor for this operation than that of a vicious circle might be that of a dog chasing its own tail. Recently the Bank of Japan has begun a program of purchasing the shares of businesses from the commercial banks to try to render them once again liquid and the central bank of Brazil has begun to buy export paper due to the lack of international credit available to the sector.


The central banks could address directly the first of the twin threats by discounting bankers’ acceptances issued by the commercial banks for the expansion of productive facilities based on financing through employee stock ownership plans (ESOPs), consumer stock ownership plans (CSOPs), community investment corporations (CICs), or other forms of expanded capital ownership structures. The central bank can do so by [re]discounting such paper at a rate only sufficient to cover its costs, probably less than one percent. Other borrowers would have to have recourse to commercial sources of credit at market rates.


Internationally, the international financial institutions could and should establish rediscount facilities for export paper discounted by the central banks of countries with liquidity problems, thus acting as lenders of last resort to the export sector of the countries involved, with such self-liquidating obligations as collateral, rather than depending on the taxing power of distressed borrowers. In this way the IFIs could become part of the solution to both immediate and underlying problems, rather than adding to and exacerbating them.

The twin threats, if not addressed promptly and in a meaningful fashion are inexorably leading the world to disasters that will dwarf the horrors of the twentieth century. The traditional solutions are completely bankrupt. The anti-globalizers have no idea what the real problems are or what to do about them. The situation is literally one of reform or perish. Due to a real “great illusion” we are rapidly approaching a most disastrous “end of history”.

Dr. Bailey is Senior Fellow at The Potomac Foundation in McLean, Virginia. He served as Former Special Assistant to the President (Reagan) and Senior Director of International Economic Affairs, The National Security Council (1981-1984).