In our previous posting on this subject, we looked at the theoretical complaints of economists the AI engine “Claude” gave to explain why economists reject Louis Kelso’s Binary Economics. While there was some validity to the theoretical complaints, they were fairly easy to deal with once we identified the differences in assumptions between Kelso’s Binary Economics and mainstream economics. There was quite a bit of confusion, but that is only to be expected because many of the critics don’t really know too much about Binary Economics . . . and some of them aren’t too clear on their own paradigm, either.
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| Louis O. Kelso |
Be that as it may, today we look at the “Monetary and Credit Critiques.” Responding to these was a bit disheartening, because while the theoretical critiques of Binary Economics were confusing, the monetary and credit critiques are just plain off-the-wall. Claims are made — at least according to “Claude” — that simply aren’t true, either about Binary Economics or money and credit. Specifically:
· The “Self-Liquidating Credit” Mechanism Is Questioned. Kelso’s proposal that new capital formation could be financed through central-bank-issued, “self-liquidating” credit — without inflation — is widely disputed. Critics argue that injecting new credit into the economy to fund asset purchases is inflationary by standard monetary analysis, regardless of whether the assets eventually generate returns. The Fed’s discount window was never designed for, nor does it function as, a broad-based equity-financing mechanism.
· Capital Credit Insurance as a Hidden Subsidy. The proposed capital credit insurance pools (to replace collateral requirements) are seen by critics as either a disguised government subsidy or an actuarially problematic risk-pooling scheme. Skeptics ask: if the loans are truly self-liquidating from productive assets, why is insurance necessary at all?
Let’s take the inflation issue first. Right off we run into a slight problem: what do the critics mean by inflation? Kelso is quite clear: inflation consists of a rise in the price level due to the amount of money increasing faster than the supply of marketable goods and services, or other event that has the same effect, e.g., a decrease or less rapid rise in the supply of marketable goods and services causing supply to lag behind demand.
The former is “demand-pull” inflation. It can be eliminated as a major factor in the economy by tying increases or decreases in the quantity of money directly to the increases or decreases in the supply of marketable goods and services. This is what Kelso’s monetary and financing reforms would do. The latter is "cost-push" inflation, and that cannot generally be resolved by monetary policy (unless it is monetary policy that is depressing supply).
So, what’s the problem? It depends on whom you ask. If you ask an Austrian economist, he or she will say that Kelso’s proposals are inflationary, no matter what. Why? Because to an Austrian economist of the “pure” school, any increase in the money supply is inflationary even if the price level decreases!
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| John Maynard Keynes |
As for a Keynesian of the “pure” school, inflation is defined as an increase in the price level after reaching full employment. Increases in the price level prior to reaching full employment are not “true inflation.”
And the Monetarist-Chicago school? Once they understand that Kelso is saying that no money is created until and unless there is a projected and measurable increase in the supply of marketable goods and services, they generally agree. Otherwise, they simply cop out and say it won’t work so it’s not worth even discussing it. Why won’t Kelso’s proposals work even though they have worked successfully for the better part of a century? They won’t say.
So, you see, according to the critics Kelso’s theory is — at one and the same time — inflationary, not inflationary, and unworkable even as it works. It all depends on who you’re asking and when . . . unless you are asking a Binary Economist, in which case, Kelso’s theory is neither inflationary nor deflationary. It’s off the flation scale.
Now, about that claim that “[t]he Fed’s discount window was never designed for, nor does it function as, a broad-based equity-financing mechanism.” Strictly speaking, this is a true statement. The discount window of the Federal Reserve was designed to function as a short-term equity-financing mechanism. It does not function that way at present due to the simple fact that Austrian, Monetarist/Chicago, and Keynesian economics do not recognize bills of exchange (future savings instruments) as money, only mortgages (past savings instruments).
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| PAST Savings, that is. |
You see, all three mainstream schools of economics assume as a given that money consists exclusively of claims on existing, “past” wealth (savings — “savings” understood as “unconsumed production”), not the present value of future wealth (savings). That means the only type of financial instrument they recognize is the mortgage . . . thereby violating the first principle of finance, which is to know the difference between a mortgage and a bill of exchange.
A mortgage represents the present value of wealth currently in the possession of the issuer and bears interest. A bill of exchange represents the present value of wealth not currently in the possession of the issuer and is discounted based on the risk the issuer will not have the wealth or the value thereof when the bill of exchange matures.
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| Monetizing government debt is not actually allowed |
The discount window of the Federal Reserve was designed to turn bills of exchange into “current money.” That is, the discount window was specifically designed to be an equity-financing mechanism. What Kelso added was to specify that it should finance equity through expanded ownership vehicles . . . which stipulation makes absolutely no difference whatsoever in how the discount window functions.
In contrast, “open market operations” are designed to turn mortgages into “current money.”
Weirdly, the presumed mortgage-type instruments — government bonds — which currently constitute virtually the whole of the Federal Reserve’s open market operations are not mortgages at all, because they are not really government bonds. They are government “bills of credit.” A bill of credit is a special type of bill of exchange — prohibited/not permitted under the U.S. Constitution — issued only by governments and backed by the present value of future tax collections (that’s not what the economics textbooks say, but it’s what they are).
Thus, it is not Kelso who is the innovator here, but the critics who don’t know how a central bank is supposed to function . . . as opposed to how it is being currently misused. Now, how about the claim that “[t]he proposed capital credit insurance pools (to replace collateral requirements) are seen by critics as either a disguised government subsidy or an actuarially problematic risk-pooling scheme. Skeptics ask: if the loans are truly self-liquidating from productive assets, why is insurance necessary at all?”
One might as well ask, Why have insurance at all? In any event, capital credit insurance was not even Kelso’s idea. It is already a recognized product. The problem is, capital credit insurance in lieu of more traditional forms of credit is at present available only to the rich and well-established companies and investors. All Kelso did was say that it should be available for everyone. In any event, where is the alleged government subsidy in a private sector insurance product? True, Kelso said the government should establish the capital credit insurance and reinsurance system, but we happen to think that’s a bad idea — and the theory doesn’t require it in any event.
And why is insurance necessary at all? Aren’t the loans “truly self-liquidating”? This has nothing to do with the case. Why have collateral? No banker is going to make a loan if the loan is expected to go bad, BUT (as they say) “stuff happens.” If it does, the lender wants there to be collateral to satisfy the debt, and why shouldn’t the collateral be an insurance policy? It’s difficult to understand this criticism.
Anyway, in the next posting in this series we will take a look at the Empirical and Credit Critiques.
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