The Rich are Different . . . Now

It is probably apocryphal, but Ernest Hemmingway allegedly replied to F. Scott Fitzgerald’s statement that “the rich are different” — “Yes, they have more money.”  Mmmmm . . . that was true at one time, but no longer.  Once upon a time, all the rich had was more and better of what everyone else had.  Nowadays what the rich have is not more money, but access to money and credit to become the owners of productive technology which is closed to those of us without similar access.

Financing Future Growth

We closed the previous posting on this subject by noting that while expanded capital ownership can restore Say’s Law of Markets and poke Keynesian economics and its unresolved paradoxes in the eye with a sharp stick, there was a problem.  It is itself a seeming paradox — or at least ironic — that the people who most need to become capital owners are the least likely to be able to afford it.

Backwards Capital Finance to How

      For those of you used to doing things the right way instead of getting everything all turned around, the title of this blog is “How to Finance Capital Backwards,” which is what the world has been doing for the last two centuries or so . . . or thinks it has, which amounts to the same thing.

Job Security for (Personalist) Revolutionaries

A while back in response to an item touting Capital Homesteading as a possible way to bring people together and turn the economy around in our weekly Just Third Way news roundup, someone posted a comment to the effect that the original 1862 Homestead Act was (wait for it) . . . racist!  As a way of refuting our promotion of Capital Homesteading as a way of possibly establishing a little racial harmony and putting the economy back on a sound footing, the Righteous One went on to explain that the 1862 Act was “Whites Only,” and Black homesteaders were completely unheard of.

Capital Homesteading and Social Security

It’s amazing the stories people will tell when they have no idea what they are talking about.  For example, for years we’ve been hearing that the goal of the Just Third Way is to abolish wages (which are presumably absolutely secure) and force all workers to live on profit sharing alone.

How Finance Really Works in Theory

In the previous posting on this subject, we looked at why Modern Monetary Theory (MMT) is illogical.  Specifically, it relies on a mathematical impossibility, i.e., having one equation with three dependent variables.  The bottom line is that in the Quantity Theory of Money equation, M x V = P x Q, V, P, and Q determine M, not the other way around as MMT adherents maintain.  If you manipulate M, all you do is screw up the system so that Say’s Law of Markets won’t function.

5. Man Versus Machine

From 1934 to 1935 the Brookings Institution published a four-volume set, Distribution of Wealth and Income in Relation to Economic Progress, analyzing what needed to be done in a recovery program for the Great Depression.  Unfortunately, FDR and his “Brain Trust” listened to John Maynard Keynes and went with the New Deal, rather than with something that made sense.

How to Cause (and Cure) a Great Depression

The recent frenzy in the world’s stock markets had a number of people panicking about the possibility of (yet) another crash of the magnitude of October 1929, and the possibility of another Great Depression on the heels of the Great Depressions of 1873-1878, 1893-1898, 1930-1940, etc., etc., etc. . . . although we don’t call them “depressions” now, but “recessions” ‘cause “depression” is too scary and makes the government look bad.

How Long?

Last week we got a very good question from a faithful reader.  It involved how long before we would start to realize the benefits of a Capital Homesteading program one it is enacted, and some of the details.  Pretty quickly, all things considered, as you’ll see from our response.  First, however, the question:

A Few Capital Homesteading Monetary Reforms

Hokey doke, we’ve come to the conclusion that the Federal Reserve system, the central bank of the United States, needs a few tweaks to put it back on the rails and conform to the purpose for which it was originally intended: provide liquidity for private sector growth.  Yes, there’s some stuff about regulating clearinghouse operations and so on, but the main purpose was to make certain that the private sector would always have “accommodation” for qualified industrial, commercial, and agricultural development, not finance government.

Some Thoughts on Money and Credit

Recently we had a reader ask a few questions about monetary policy under CESJ’s proposed Capital Homesteading program.  This is understandable, as the vast majority of experts in money, credit, banking, and finance are locked into “Currency School” assumptions, while the Just Third Way is based on “Banking School” assumptions.  Trying to understand the Banking School from the perspective of the Currency School is virtually impossible, as the Currency School takes some assumptions from the Banking School, but not all.

Capital Homesteading Now

As part of our continuing campaign to persuade Bob Marshall of the Virginia House of Delegates to talk to CESJ president Norman Kurland, we sent the following letter last Thursday.  As you can see, it reiterates points we’ve made before, but that are worth repeating.

Virginia’s Central Bank

Somewhat to our surprise, the campaign to get Virginia Delegate Bob Marshall to talk to CESJ president Norman Kurland has received expressions of interest not only from across the political spectrum in the Commonwealth, but from different countries.  The general feeling seems to be that the U.S. economy, while rather rocky at present, is still — relative to the rest of the world — founded on a slightly more solid grade of quicksand than most.

Restoring the Federal Reserve

As should be evident from the previous postings on this blog regarding Delegate Bob Marshall’s proposal for a study of currency reform, the Commonwealth of Virginia has a unique opportunity to lead the rest of the country in a fundamental financial reform that has the potential to revitalize the entire U.S. economy.

Avoiding Monetary Meltdown, I: Andrew Jackson’s War on the Economy

Consider this an “open letter” to Virginia Delegate Bob Marshall.  Following up on yesterday’s posting regarding Virginia Delegate Bob Marshall’s proposal to study the possibility of instituting a specie (i.e., gold and silver) currency to fend off the potential of hyperinflation due to mushrooming government debt.  Also (if we understand the proposal) the idea is to eliminate the possibility of computer terrorism destroying the financial system by making a commodity (gold), not electronic media, the only money supply.

A “Virginia-Only” Currency

Last week (February 6, 2013) an article appeared in the Washington Post about Virginia Delegate Bob Marshall’s proposal to study the possibility of reinstituting a specie currency (gold and silver) as a means of stabilizing the money supply and preventing the growing federal debt from crushing the economy.

"Just Say 'Bah!'"

Almost any performance by the late, great William Powell (1892-1984) is a pleasure to watch. The Thin Man films are classic sophisticated crime comedy-drama without being stuffy or condescending. A typical Nora Charles comment to her low-life husband Nick when he asked the identity of a couple who hailed them from a limousine in After the Thin Man (1936) was, "Oh, you wouldn't know them, darling. They're respectable." A quick sketch of Nick's character that managed not to insult or put down. Much.

Of course, you can always get too much of a good thing. While on an audit trip in Germany once, the only film that the Armed Forces Network seemed to have was Life With Father (1947). It followed Soul Train almost every day. And preceded it, too. As a result, the scenes are engrained in my brain. Deeply.

One of these is the scene in which Clarence Day, Sr. — played by William Powell, of course — is telling his wife (played by Irene Dunn) how to feel better when she's under the weather. Father — Mr. Day — is unaware that the boys slipped some patent medicine into her tea . . . because the label said it was "good for women's complaints" . . . "And Mother's been complaining!" a young Martin Milner (later Officer Jim Reed on Adam-12) as George says brightly.

Father's pep talk to Mother on "How To Feel Better" is quintessential Father. He doesn't let anything get him down. If he feels poorly, he just banishes the illness by saying, "Bah!" and goes about his business. Self-confidence is everything. It's all how you look at it. You refuse to give in. Just say "Bah!" Mother, a Typical Incomprehensible Female, runs crying from the room wailing that "Clare" just doesn't understand, while Father stands there completely baffled at his wife's refusal to take such sound advice.

Of course, when Father finds out that what made Mother sick was a dose of something that killed the neighbor's dog, he relents and calls the doctor and the minister. Father might be pompous and bursting with self-confidence, but he is no fool.

And that brings us to the point. In today's Washington Post, Robert Samuelson lets loose with a verbose "Bah!" about the economic downturn and the remedies proposed ("Inflation is Not the Answer," 08/25/11, A15). True, he's right that inflation is not the answer. You don't get out of a hole by digging it deeper.

You also don't get out of a hole using only the Power of Positive Thinking and maintaining that all problems are due to a lack of confidence. Be confident. Just say "Bah!" and everything will be all right.

Except that the economy has been slipped a rather heavy dose of dog poison, and nobody has thought to call the doctor.

Just saying "Bah!" isn't going to a thing. What is needed is substantial tax reform and meaningful financial reform.

Okay, you've heard this before, so we'll just quickly recap.

One, eliminate most deductions, tax credits, and all the other complications that have burdened the Internal Revenue Code and turned tax preparation from a painful civic duty into a living hell. I read a few years ago that in one major corporation the IRS maintains a permanent office and staff for continuous audit, and the corporation's annual tax return is the equivalent of 45,000 pages.

Two, end payroll taxes, merge Social Security and Medicare into general tax revenues and tax all income from whatever source derived above a meaningful personal exemption — say $30,000 per non-dependent and $20,000 per dependent — at the same rate.

Three, prohibit the Federal Reserve from dealing in government securities of any type, except to divest itself of existing holdings as the debt is repaid.

Four, provide financing for new capital formation and economic development directly to the private sector by reopening the discount window for qualified industrial, commercial and agricultural paper issued interest-free (but not cost-free) by commercial banks to finance capital projects.

Five, extend such credit in ways that make new owners out of people who currently own little or no capital.

If you want to advance these goals, don't just sit (or stand) around saying "Bah!" and wondering at the ineffectiveness of your solution. Join the Coalition for Capital Homesteading. Father (we don't know about William Powell) would approve.

#30#

Unplanned Obsolescence

Today's Wall Street Journal had what many might consider the media coup de grace for the Obama presidency. Fouad Ajami's op-ed piece, "The Obsolescence of Barack Obama" (Wall Street Journal, 08/11/10, A15) is a devastating critique. It paints a picture — true or not — of a man who has utterly failed, a president who, less than halfway through his term of office, has not just been relegated to the dustbin of history, but who has already been collected and incinerated.

That's a pity on more than one account. Primarily, of course, the opposition isn't offering anything much better. Less spectacularly bad, of course, but still not much better in objective terms. To all appearances, the liberal Democratic hegemony with no vision will be overturned in a couple of months by a conservative Republican hegemony with no vision. The only advantage is that, with Barack Obama to blame for everything, the lack of vision will not become obvious for at least four more years. Precious time will be thrown away arguing about who is more to blame for the rapid slide of the United States into a second rate economic, and third rate moral power.

The worst thing about the president's unplanned obsolescence, however, is that it can very easily convince him that "they" were out to "get him" all along. The signs of incipient "Nixonism" are there, from the grandiose gestures to the blaming others (especially George W. Bush), and, of course, the increasing suspicion that the media are after him. It would be very easy for Mr. Obama to give up, blame everyone else for his failure, declare that in two more years they won't have Barack Obama to kick around any more, and sit as a self-pitying and ineffectual lame duck for the rest of his term.

Or he could pull off another miracle, only this time one with more substance. He needs a vision and a plan, or at least something other than warmed over Keynesianism. That "something" can be found in the immediate passage of the Capital Homestead Act. Within three months of the passage of the Act, it is entirely possible that a real economic recovery will be under way — not a recovery that the politicians and Wall Street manufacture to give the consumer enough false hope to start borrowing and living beyond any possible means again.

Take one small example. Right now companies are very prudently holding on to cash, neither reinvesting it in the company nor paying it out as dividends. Under Capital Homesteading, however, there is a source of financing that does not entail either retained earnings or debt. New equity can be issued and sold to investors who purchase "full payout" shares on credit, and who collateralize their loans with capital credit insurance.

The company is not on the hook, because equity is ownership, not debt, and there is no obligation to pay if the profits aren't there. The investor is not on the hook, because if the stock fails to generate sufficient dividends the insurance will take care of it. Admittedly, the insurance company is on the hook, but that is only if the investment doesn't pay off. In any event, the insurance company should have factored the risk of failure into its premiums, and collected enough to make good any losses.

Current cash holdings above working capital needs could be paid out as dividends to existing shareholders, increasing consumption income and stimulating the economy naturally. If done quickly enough, it might even be possible that the old low dividend tax rate will still be in effect at the same time that the dividends are tax deductible at the corporate level. This brief window wouldn't last very long, of course (a basic principle of fair taxation under Capital Homesteading is that ALL income above a very generous exemption be taxed at the same rate) — but it might be just long enough to give a terrific boost to consumption at just the right time, and be a tremendous incentive to pay out as much as possible as fast as possible before the window closes. The rich receiving the dividends wouldn't be able to reinvest them in financing new capital, and would be "forced" to spend the "windfall" . . . increasing effective demand and creating new jobs without a government subsidy.

It's all up to Obama, now. Will he be satisfied with going down in history as the worst president in American history — or be ranked among the top three, right after Washington and Lincoln? It's his decision.

#30#

Own the Fed — the Program, Part X: Capital Credit Insurance as Collateral

In the previous posting in this series we explained why all money creation by the State and financial institutions, including the central bank, for non-productive purposes must stop. Expansion of bank credit for anything other than capital projects that are expected to pay for themselves within a reasonable period of time or to monetize existing inventories of marketable goods and services is illegitimate. Creating money for other purposes must be discouraged, if not prohibited outright. This should be done both by the most effective method of structuring of the system properly with adequate internal controls, as well as by passing external laws and regulations enforced by the State or appropriate regulatory agencies. The only legitimate money creation is for properly vetted and adequately collateralized capital projects intended to result in the production of marketable goods and services, or to monetize existing inventories of marketable goods and services.

Further, all capital projects financed with new money backed by the present value of future marketable goods and services must have their financing structured in a way that creates new owners rather than concentrating ownership of the means of production in fewer and fewer hands. Only in this way will the income generated by the capital after its financing has been repaid be used for consumption, not reinvestment. This will sustain aggregate effective demand, provide an adequate tax base, supply people with an adequate and secure income, and keep the economy stable.

This, of course, assumes a complete overhaul of the tax system. The goal of tax reform is twofold: 1) Simplify the tax system and make it more equitable, leaving more money in people's pockets to meet their own needs without recourse to government assistance, and 2) Return the tax system to its proper function of raising revenue to meet legitimate State expenditures, and not as a tool for social engineering. Our object in this survey, however, is monetary reform, not fiscal reform — at least directly. Important as reforming the tax system is, we will only refer to it in passing or as appropriate to make a specific point.

To return to the subject of monetary reform, we specify the present value of future marketable goods and services as the source of backing for new money used to finance new capital formation and new ownership opportunities for a good reason. By ancient rights of private property, the present value of existing marketable goods and services belongs, obviously, to existing owners of the labor, land, and capital that produced those same goods and services. Many of the troubles afflicting the economy of many countries and regions — and thus the political systems — can be traced directly to the fact that most people own little or nothing in the way of income-generating capital assets. As Kelso and Adler explained,

Under a system of private ownership of capital, the ownership may be highly concentrated in the hands of the few at one extreme, or widely diffused among the population at the other extreme; or its degree of concentration or diffusion may fall somewhere between these two extremes. Insofar as it is highly concentrated, it gives the few economic power with which they can exert undue influence on the organs and personnel of government. Insofar as it is widely diffused, it gives the people generally the economic independence they need to bulwark their political liberty. (The Capitalist Manifesto, op. cit., 94.)

Our concern at this point, however, is with new capital formation, not existing capital in which present owners have rights — and in which they must, at all costs, be secure if these reforms are to have any credibility, a measure of support, or even a modicum of acquiescence among the currently wealthy. It makes no sense to open up capital ownership to everyone, if ownership itself ceases to have any meaning. We cannot advocate diluting or abolishing the property rights of some, even for the benefit of the poorest of the poor, and expect the new property rights of the poor to be any more secure the moment we decide that they have too much, are not fit to be owners, or whatever other flimsy justification comes to mind to help us get what we want — usually power over others.

We use a present value approach in this analysis for a simple reason. Comparing the price of a capital asset with the present value of the anticipated future stream of income generated by the production of marketable goods and services is often used to decide if a capital asset is a good investment. If the "net present value" (the present value of the anticipated future stream of income less the cost of the asset) of the asset is zero or greater, then the asset is usually considered a good investment, that is, the asset is expected to generate at least enough to cover the actual cost of the asset plus the opportunity cost associated with foregoing another investment. If the net present value of the asset is less than zero, then the asset is usually considered a bad investment, that is, the asset is not expected to generate at least enough to cover the actual cost of the asset plus the opportunity cost associated with foregoing another investment.

Obviously, the net present value method of trying to determine the value of a capital asset, in common with all forecasting in all fields of human endeavor, is based on a number of semi-educated estimates and a lot of guesswork. Other factors also enter in to a decision whether to invest your time, effort, and credit into a capital project. There is, for instance, no way to know for certain whether a capital project will generate a profit or a loss. There is also the fact that some people invest in a less remunerative project for personal satisfaction and the expected intangibles derived from that particular project or endeavor.

On a more "practical" level, when deciding whether to invest in new capital, a prudent investor is extremely conservative about the anticipated stream of income from the production of marketable goods and services. Once the asset is obtained, however, the investor — if a worker-owner — tends to produce (or try to produce) at the maximum level, thereby maximizing income.

The point here, of course, is that neither the buyer nor the seller know that the asset will, in fact, be as productive as either hopes or fears. If the individuals most closely associated with the transaction cannot make this determination, then, how likely is it that a lender will be able to do so?

It is because of this uncertainty about the future that lenders require additional assurance that they will get their money back — collateral. They cannot simply rely on financial projections and present value calculations based on more or less educated guesses. Of course, we include in the category of lender both people with existing accumulations of savings to loan out (the existing supply of "loanable funds") and financial institutions that have the power to issue promissory notes and thereby create money through the expansion of bank credit (commercial and central banks).

The problem becomes how to finance the acquisition of capital by people who currently lack the wherewithal — the existing accumulations of savings that generally constitute collateral — to acquire and possess a meaningful ownership stake of income generating assets . . . without taking anything from current owners of wealth (who thereby have an effective monopoly on existing collateral) except the virtual monopoly over ownership of future, as-yet uncreated wealth.

We have already examined at great length and disproved the claim that existing accumulations of savings are necessary in order to finance new capital formation. That being so, there should be nothing standing in the way of people who lack ownership of existing accumulations of savings or capital investment from acquiring ownership of new capital assets.

Logically, that is the case. In practicable terms, however, there is what amounts to an insurmountable barrier against people without existing accumulations of savings acquiring and possessing private property in the means of production. That is the universal demand for collateral to secure any loan. Existing accumulations of savings may not be used in many cases to finance capital formation directly, but existing savings — usually in the form of corporate retained earnings — are critical in providing collateral for financing new capital formation.

Kelso and Adler addressed this problem in their second book, The New Capitalists (op. cit.), highlighting the critical nature of the universal demand for — and necessity of — collateral in securing financing for new capital formation. They proposed to replace traditional forms of collateral with capital credit insurance and reinsurance.

Kelso and Adler briefly addressed the idea of insurance in The Capitalist Manifesto as well. They introduced the concept both as a replacement for traditional forms of collateral as to protect ownership income. The latter, of course, was in answer to the all-too-common objection by elitists that ordinary people should not be subjected to the risks of ownership, or are somehow not capable of owning a meaningful private property stake in the means of production, and so on.

Evidently the risks associated with being utterly dependent on an employer who may or may not be beneficent are preferable to an ownership stake in the means of production — as long as you are not the one forced into a condition tantamount to slavery. As Hilaire Belloc pointed out in The Servile State (1912), where the small owner worries about whether his or her efforts will generate sufficient income for his or her family and dependents, the proletarian (non-owning) wage worker is suffused with the fear of "getting the sack," that is, losing his or her job.

Consequently, the proletarian necessarily gives absolute fidelity, obedience and first priority in all things, not to his or her own interests and those of the people dependent on him or her, but to whoever or whatever can best secure the worker a wage system job, be it the employer, the union, or the State. This, naturally enough, builds conflict into the system, both where the wage worker finds him- or herself in conflict between his or her own best interests, and those of the employer, union, or State, as well as in the conflicts that necessarily arise between employers, unions, and the State in the inevitable struggle that ensues as each one attempts to gain absolute control over the worker and thereby secure its own power.

To break the dependency of the propertyless worker on those who, however well intentioned, cannot have the best interests of the worker as a person at heart, Kelso and Adler proposed a type of portfolio insurance to safeguard capital income the way life insurance safeguards labor income:

Where a household is primarily dependent for support upon its ownership of capital, the primary risk to be guarded against is simply the business risk inherent in a competitive and technologically evolving economy. In large measure this risk can be minimized through investment diversification, but beyond this it should be possible to devise casualty insurance designed to protect the family income against a coincidence of business failures that would materially impair the support derived from capital holdings. (The Capitalist Manifesto, op. cit., 241.)

It is the idea of insurance as a replacement for traditional forms of collateral — that is, existing accumulations of savings — where insurance can play its most important role. This is not to say that Kelso and Adler were hostile to savings, as some might infer from the subtitle of The New Capitalists: "A Proposal to Free Economic Growth from the Slavery of Savings." Their "hostility," if you even want to call it by that misleading term, was reserved for the fixed — and erroneous — belief of Currency School adherents that new capital formation can only be financed out of existing accumulations of savings. That is, despite the fact that this dogmatic belief has been disproved time and again, Currency School adherents firmly believe that "saving" is always defined in terms of cutting current consumption, and that reductions in consumption necessarily precede investment in new capital.

On the contrary, as Moulton explained at some length in several of his books, "the formation of capital is accompanied by a virtually concurrent expansion in the production of consumption goods." (The Formation of Capital, op. cit., 47.) In English, that means periods of capital expansion are not necessarily preceded by cuts in consumption. The assumption of the Currency School — and thus the conclusions of Keynesian, Monetarist, and Austrian schools of economics to the degree that they rely on that assumption — is wrong. The historical data Moulton assembled from 1830 to 1930 in the United States show a consistent pattern of increases in capital investment preceded not by decreases, but by increases in consumption.

Moulton's observation presents us with an apparent paradox. If cuts in consumption are absolutely necessary in order to save and accumulate the wherewithal to finance new capital formation, where do investors obtain the savings necessary to finance new capital formation when consumption, far from declining, is increasing?

The answer is, "from the future." The concept of financial feasibility is predicated on the fact that a capital project is expected both to pay for itself and generate an acceptable return to the investor over its useful life. An astute investor purchases a capital asset — even out of his or her existing accumulations of savings — on the expectation that those savings will be replaced in the future as the capital becomes productive and generates a stream of income through the sale of marketable goods and services.

Future income generated by the new capital is used in part to repay the acquisition loan or replace the savings expended instead of being used for consumption. In that sense, yes, consumption is being reduced in order to finance new capital formation. The key, however, is that refraining from increasing consumption in the future in order to repay the acquisition cost of capital is fundamentally different from reducing current consumption in order to accumulate savings for the same purpose.

In the former case, the investor can maintain, even increase consumption as his or her income rises and only a portion is used for debt service payments on the capital. In the latter case, the investor necessarily reduces consumption, thereby rendering not only his or her investment less feasible, but, if all or even a determinant amount of new capital formation is financed by cutting current levels of consumption, having a detrimental effect on the entire economy.

The problem, however, is how to guarantee that capital acquisition loans will, in fact, be repaid, even when the capital project fails to generate sufficient income to justify the investment. The answer is "collateral" . . . but most people lack something — existing accumulations of savings — they can use as collateral.

Kelso and Adler's answer to this conundrum is capital credit insurance and reinsurance. Technically, insurance is coverage or security by means of a contract that binds one party to indemnify another party against a specified loss or losses in return for premiums paid. Reinsurance is "insuring the insurance." That is, reinsurance is the practice whereby an insurer (usually an insurance company) transfers a portion of the risks he or she (or it) has assumed to someone else — the "reinsurer." The legal rights of the insured — the policy holder(s) — are not affected in any way by this practice. The insurer (the original issuer of the policy) or his or her assigns remains liable to the insured for any benefits or claims.

Because the role of collateral is to insure a lender against the risk of loss, the substitution of an insurance contract for traditional forms of collateral seems obvious once it is stated. That is why Kelso and Adler expressed such bafflement that so obviously beneficial an improvement had not been adopted: "It is singular . . . that we have not to any significant degree employed an insurance system as such in dealing with the risk of entrepreneurial error." (The New Capitalists, op. cit., 57.) As Kelso and Adler explain the concept,

The existence of an insurance fund for capital acquisition financing should help to reduce underwriting costs, since the risk of failing to sell qualified stock issues within a reasonable time might either be greatly diminished or entirely eliminated. This, with a revision of the corporate income tax laws designed to discourage long-term debt financing, would not only dry up a major source of concentration but would also facilitate equity diffusion. It is important to note that such an insurance arrangement — let us call it the "Capital Diffusion Insurance Corporation" — would not directly underwrite any of the risks of the business enterprise. That is the function of the stockholder. It would only be insuring or guaranteeing the stock subscriber's or stock purchaser's obligation to pay for the stock that he purchases. (The Capitalist Manifesto, op. cit., 241.)

The concept and proposal are greatly expanded in The New Capitalists. Of most use in this survey, however, are not the technical details of the proposal. These are subject to change in any event as the concept is adapted to existing conditions and the needs of the market. What we're after here is the basic proposal, with the details to be fleshed out when specific legislation is developed, and the insurance industry designs the new products.

The proposal can be outlined very briefly. A potential owner — or, more likely, the potential owner's investment advisor (assuming that the potential owner doesn't automatically channel his or her capital credit allocation into the company for which he or she works) locates a financially feasible and properly vetted investment. The potential owner brings the investment to a commercial bank loan officer, who further scrutinizes the loan. Assuming that the investment passes muster, the loan officer passes it on to an insurance company to do an assessment of the risk and determine the risk premium. This provides an additional level of scrutiny.

Some of the requirements for an investment to qualify are 1) full payout of all earnings attributable to the shares, 2) tax deducibility of such dividends at the corporate level, 3) all dividends received subject to taxation at the ordinary rates except for any and all dividends used to make acquisition debt service payments, and 4) full voting rights attached to the shares going to the investor. Taxation of dividends at ordinary rates to the recipient for anything not used to make debt service payments and meet associated investment costs (such as the premiums on capital credit insurance policies) will be largely offset for most people by greatly increasing the personal exemption to realistic levels, eliminating most deductions except for increased deductions for education and healthcare, and a deferral for any and all qualifying assets put into a Capital Homestead Account.

Assuming everything is in order, the loan officer makes the loan and purchases an insurance policy on the loan, paid for with the risk premium by means of which financial institutions currently "self-insure" against loss. The premium for a capital credit insurance policy on a loan will, of course, be much less than the usual risk premium, however, even for a similar loan. This is because the typical risk premium on a traditional loan is determined based on the risk associated with that particular borrower, with no spreading of the risk. The premium for an insurance policy made for the same purpose, even for a loan made to the same borrower, will be much less because the risk is spread out among an entire population of loans instead of just a single individual. All loans are therefore "non-recourse" against the borrower, who thereby protects his or her other assets.

In order to make certain that people with absolutely no savings at all and a complete inability to cut consumption by any degree whatsoever can obtain capital credit to purchase income generating assets, the bank making the loan should pay the premiums on the policy, although the full cost of the premiums will be passed through to the investor once the investment starts generating dividend income. In addition, the bank will be compensated for the service it performs not by an ongoing interest charge, but a one-time service fee on each loan, taken directly out of the loan principal (discounted) to ensure that no existing accumulations of savings are needed at any step.

To make certain that all loans are backed at least 600%, all qualified loans — and no commercial bank would find it profitable to make loans other than qualified loans — will be rediscounted at the Federal Reserve, which was established for just this purpose. Thus, all loans will be backed by 1) the present value of the assets they were made to finance (100%), 2) the capital credit insurance policy (200%), which is in turn backed up by the insurance pool (300%), and the reinsurance pool (400%), not to mention 100% reserves (500%), and the full faith and credit of the federal government that by law assumes direct responsibility for all issues of the Federal Reserve (600%), which is in turn backed up by the tax base of a much sounder economy. In contrast, today's recognized money supply, M1 and M2, are backed up by government debt, as well as at present (April 2010) more than $1.2 trillion in toxic mortgage-backed securities, both of which are supported by a seriously depleted and decayed tax base in a disastrously weakened economy.

As the investment becomes profitable and begins paying dividends, the borrower will make the debt service payments, thereby redeeming his or her promissory note. The bank cancels the money, terminating the lien it took on the assets financed by the loan. If the investment fails to generate sufficient income and the loan goes into default, the capital credit insurance policy pays off. This allows the bank to cancel the loan and the amount of money created by the loan, avoiding any danger of inflation. To avoid encouraging banks to make deliberately bad loans in order to make a fee and increase profits unjustly, the full amount of a loan will not be insurable.

As an additional safeguard, no insurance or reinsurance company will be permitted to invest its insurance pool in the industry or group of industries for which it issues capital credit insurance policies.

In this way Kelso and Adler devised a way out of the Keynesian liquidity trap without the necessity of the State relying on deficit spending or for the Federal Reserve to manipulate interest rates artificially. Capital credit insurance would also make it possible for people who currently lack existing accumulations of savings to become owners of productive assets.

#30#

Own the Fed — the Program, Part VIII: Reform the Fed

In the previous posting in this series we concluded that if a central bank does not adequately serve the purpose for which it was invented, it must be reformed. This is obviously plain common sense. If an institution works so as to inhibit or prevent people from realizing their fullest potential as human beings, the natural course of action is to repair or reform that institution so that it carries out its purposes adequately. Naturally enough, this raises the question as to the special role of a central bank — or any bank, for that matter.

Bank credit is the primary means by which people acquire ownership of the means of production. The need for reform of the central bank must therefore be judged by how well the central bank and the commercial banking system assist every individual in becoming a direct owner of a meaningful private property stake in income-generating assets. As should be obvious, not only is the right to be an owner (the right to property) inherent, that is natural or absolute, in every human being by definition, ownership of the means of production is the chief means by which each person secures the right to life and liberty, and carries out the task of acquiring and developing virtue — pursuing happiness and safety.

As one authority put it, "It is precisely the object of the positive law to render the citizen virtuous." (Heinrich Rommen, The Natural Law. Indianapolis, Indiana: Liberty Fund, Inc., 1998, 48.) Thus, "The law, therefore, should favor ownership, and its policy should be to induce as many as possible of the people to become owners." (Pope Leo XIII, Rerum Novarum ("On Labor and Capital"), 1891, § 46.)

The fact that the right to private property — the right to be an owner — is absolute in every human being, of course, does not change the fact that the exercise of property must be limited. Limitations are generally imposed by the needs of the owner and other individuals, as well as the common good as a whole. As Rommen explains, continuing the passage quoted above,

It is not merely a question of maintaining order, or external peace; the law should rather act as a medium of popular education to transform those who live under common legal institutions into perfect citizens. For this very reason positive norms, determinate coercive measures, and a more exact definition of the circumstances in which the general principle shall be applied, are imperative. Thus the definition of what theft consists in is given with the lawfulness of private property. But the punishment which should follow theft, if arbitrariness is to be avoided, requires, with respect to the sentence and its execution, exact legal provisions which vary with times, cultures, and individual peoples.

Here, in connection with the positive law which is therefore always "something pertaining to reason," St. Thomas arrives at the nature of law. It has to do essentially with community life. On the other hand, it is distinguished from and contrasted with social ethics through its being directed to external order. The law wills that man conduct himself in such and such a manner; it concerns the external forum (vis directiva). It is the norm to be enforced: compulsion (vis coactiva) is proper to law, not to morality. (Rommen, The Natural Law, op. cit., 48-49.)

Unfortunately, what with today's general inability to think in any logical fashion, many people confuse what pertains to both the law and morality, with what pertains to the law alone, and to morality alone. The paradoxical belief grows up that what is legal must, ipso facto, be moral, but that what is moral must not be subjected to enforcement by the law. In reaction, those who dimly perceive that there are matters that pertain to both law and morality begin asserting that the State has the job of enforcing all that is moral, whether or not the matter is truly enforceable by human law, or even properly comes under human law at all.

The "trick" (if you insist on so terming it) is to balance what people are willing to accept at any stage of development of their culture or civilization, with what is necessary for the full development as human persons within that society. Thus, at various times in history, moral authorities have "allowed" such things as polygamy, slavery, capital punishment, capitalism, divorce, war, and the wage system not because such things are inherently good or the proper way to organize the social order, but because of the "hardness of people's hearts" and the fact that society was not yet ready to move to something higher.

There are even instances in which society must tolerate something that is objectively evil in and of itself, if the unintended result of attempting to abolish it would result in the destruction of the social order. Where something objectively evil exists in society and is widely accepted, the proper response is not to coerce people by means of the law to stop the evil act or acts, but to organize with an eye toward the common good, changing our institutional environment and people's attitudes and beliefs to conform more closely with the demands of the natural law.

Consequently, and consistent with the principles of the Just Third Way, we believe that there are seven reforms essential to restoring money, credit, and banking to their organic roots and bring these unique institutions back into conformity with the roles they are designed to fill, with special focus on the central bank. Obviously, any reforms must be carried out in a manner consistent with human nature and the demands of the common good, and with ends in view that are equally consistent with nature. The necessary reforms are:

• Immediate cessation of monetizing government deficits.

• Establishment of capital credit insurance and reinsurance to serve as collateral.

• Establishment of a "two tier" interest rate to separate "good" (i.e., productive) credit from "bad" credit for consumption, speculation, and government spending.

• A 100% reserve requirement to ensure full asset backing of the currency.

• Restoration of the autonomy of regional Federal Reserve banks.

• Extend the term of qualified paper discountable at the central bank to allow for financing of long-term capital projects.

• Direct ownership of the Federal Reserve by every citizen.

Obviously the framework within which such reforms are required or even comprehended is substantially different from the general paradigm within which most policymakers and academic economists currently operate. Since the American Civil War, there has been a fundamental shift in our perception of the State and the role the State is supposed to fill. From a country in which "society governs itself for itself" (Alexis de Tocqueville, ("The Principle of the Sovereignty of the People of America," Democracy in America, Volume I), the United States has become, by and large and by degrees, a country in which "the supreme power, the determining efficacy in matters political, resides in the people — not necessarily or commonly in the whole people, in the numerical majority, but in a chosen people, a picked and selected people." (Walter Bagehot, The English Constitution. Portland, Oregon: Sussex Academic Press, 1997, 17.) Bagehot's emphasis on the word "chosen" was clearly intended to denote some form of election by a divinity, e.g., the Jews described as the "Chosen People," not by the electorate.

What confuses many people is that the outward forms of political democracy have been preserved, even extended to great numbers and classes of people, as well as into areas in which "politics" in the narrow sense does not even belong. As a case in point, we need merely mention the oddity of asserting same-sex marriage as a civil right. On the contrary, marriage is a domestic institution, not a civil institution. Marriage is thus a domestic, not a civil right. The State has no competence to define marriage, and no power other than to protect the civil rights of persons in a marriage and the common good as a whole — not to define the institution itself. Asserting that the State does, in fact, have the power to "re-edit the dictionary" with respect to marriage or anything else is to give the State totalitarian control over the whole of society and over every person. Every person and every thing becomes a "mere creature of the State." (Pierce v. Society of Sisters of the Holy Names of Jesus and Mary, 268 U.S. 510 (1925).)

The only protection ordinary people have against the intrusion of the State into areas beyond the competence of the State are the inherent rights of each human person embedded in the ordinary laws of society. These, however, have become effectively meaningless with the economic disenfranchisement of ordinary people. Sovereignty of the people is replaced by the sovereignty of a presumed "chosen" elite. Most often and most effectively, this is through the establishment of what Pope Pius XI termed a "despotic economic dictatorship." This "is consolidated in the hands of a few, who often are not owners but only the trustees and managing directors of invested funds which they administer according to their own arbitrary will and pleasure." (Quadragesimo Anno, op. cit., § 105.)

The establishment and maintenance of an economic dictatorship has given rise to a political despotism that people of previous generations could not even imagine. Largely this has been because the presumably divine statutes that govern the regulation and creation of money and credit under the tenets of the Currency School have obscured the loss of liberty, or rendered it more or less palatable as a tradeoff to gain material security or other presumed or anticipated advantages. The ownership-concentrating and property-destroying operation of the money, credit, and banking systems under these assumptions are taken as a given.

The political system, in tacit acknowledgment of Daniel Webster's dictum that "power naturally and necessarily follows property," has been modified imperceptibly over the years, keeping pace with popular economic disenfranchisement. The political system, while leaders necessarily pay lip service to popular sovereignty, has become increasingly despotic, matching the economic despotism that results from unquestioning acceptance of flawed principles of economics and finance.

The outward forms have been preserved, but the substance, once ordinary people have been stripped of the means of maintaining themselves through direct ownership of the means of production, is gone, seemingly forever. Even an otherwise astute analyst such as Albert Venn Dicey could be fooled by the maintenance of outward forms and the removal of the substance. Dicey failed to take into account the effect that loss of economic power inevitably has on the effectiveness of political power. As he commented,

Where the right to individual freedom is a result deduced from the principles of the constitution, the idea readily occurs that the right is capable of being suspended or taken away. Where, on the other hand, the right to individual freedom is part of the constitution because it is inherent in the ordinary law of the land, the right is one which can hardly be destroyed without a thorough revolution in the institutions and manners of the nation. (A. V. Dicey, Introduction to the Study of the Law of the Constitution. Indianapolis, Indiana: Liberty Fund, Inc., 1982, 119-120.)

Dicey was absolutely correct that it would take a "thorough revolution in the institutions and manners of the nation" to effect so profound a change as the shift from an orientation on natural law ("the rule of law"), to legal positivism, in which the law becomes what the judges or anyone else with enough power says it is. Nevertheless, although Dicey taught at the London School of Economics, he did not take into account the devastating effect that the loss of private property in the means of production has on ordinary people in an economy, and the degree to which political power relies on economic power.

Political democracy simply cannot survive unless built on a solid foundation of economic democracy. It is no coincidence that the rapid spread of positivism in all its forms as the prevalent philosophy always accompanies the decay and eventual disappearance of private property in the means of production for the great mass of people. Thus, economic disenfranchisement effects the "thorough revolution" in our "institutions and manners" that Dicey declared must occur before there could be a loss of liberty and the overturning of the rule of law.

Nor is this changed in any way by the delusion that wages and fixed benefits, whether guaranteed by the State or by some private agency, can secure economic (and thus political) power to the ordinary wage earner. Wages secure dependency — slavery — not sovereignty, as modern economic and political theories make clear, especially those of Keynes. Our inalienable — inherent — rights to life, liberty, property and the acquisition and development of virtue secure our sovereignty and protect our human dignity, not State fiat, welfare, high fixed wages and benefits, or increased external regulation designed to impose desired results rather than protect equality of opportunity and a level playing field.

Loss of personal sovereignty and lack of respect for essential human dignity are principally due to the presumed inexorable necessity of only financing capital formation — and thus inhibiting or preventing widespread direct ownership of the means of production — out of existing accumulations of savings. The New Deal, President Obama's "change," President Clinton and Prime Minister Blair's "Third Way," even modern capitalism and socialism, are all efforts to accommodate both our political systems and the financial markets to the presumed reality of the necessity of existing accumulations of savings to finance capital formation. This is what Kelso and Adler accurately termed, "the slavery of savings."

Thus we have a supreme irony. The Federal Reserve was established "to furnish an elastic currency, to afford means of rediscounting commercial paper, [and] to establish a more effective supervision of banking in the Unites States," or, briefly, to supplement the amount of savings in the economy plus what the commercial banks could safely create given existing reserves. With the changeover from a predominantly asset-backed currency to a predominantly debt-backed currency as a result of the New Deal — we specify "currency" because private sector money, at least 60% of the money supply, is necessarily asset-backed, or it would not be acceptable in the channels of commerce — the need to restore asset-backing becomes critical. The currency must be 100% asset-backed, not 60%-and-falling asset-backed.

Clearly we need to reform our "institutions and manners" to conform more closely to the natural moral law than they do at present. The specific techniques to achieve this end are not, however, the point of this survey. William Ferree outlines the proper and most effective approach to reforming our institutions and manner in Introduction to Social Justice (1948), which is highly recommended for study and review before starting to organize with others to carry out such a "thorough revolution." As important as the techniques of social justice are and remain, however, our concern at this point is with the specific reforms of institutions and manners to be sought, not how to achieve the desired end.

In general, the first step is to reorient people away from a misplaced faith in the State, and back to the use of reason in applying the precepts of the natural law. That is, people must relearn to use basic common sense, especially with respect to the structuring of the economic order. The law, as people of sense have known for millennia, is found in reason alone. If something that the State (or, more usually, the State's agents) or some other authority declares contradicts something established by reason, there is a good chance that the declaration is false.

Thus, the continued assertion that only existing accumulations of savings can be used to finance capital formation — disproved many times through history and every day in the financial markets — must be jettisoned. There must be a restoration of Say's Law of Markets and the real bills doctrine that, taken together, are integral to the understanding of money as anything that is or can be used in settlement of a debt. In short, there must be a reorientation back to sound banking theory, in which a bank is understood as a financial institution not only takes deposits and makes loans, but issues promissory notes — "money" — and money itself is clearly understood as a derivative of production. These are the basic principle of the Banking School.

Consequently, there must be a reorientation away from the tenets of the Currency School, in which "money" is understood as accumulated savings — but only in the form so-defined by the State, which thereby claims dominion over the whole of economic life, an "economic dictatorship" to match the growth of State absolutism. As Keynes declared, both illustrating the shift from rule of law to rule of will and the insidious, even deadly reliance on accumulated savings as the only source of capital financing,

The Age of Chartalist or State Money was reached when the State claimed the right to declare what thing should answer as money to the current money-of-account — when it claimed the right not only to enforce the dictionary but also to write the dictionary. To-day all civilised money is, beyond the possibility of dispute, chartalist. (Keynes, A Treatise on Money, Volume I, The Pure Theory of Money. New York: Harcourt, Brace and Company, 1930, 5.)

We need merely draw the attention of the reader to the claim that the State has the power "to write the dictionary" to demonstrate not only the terrifying dangers inherent in adherence to the tenets of the Currency School, but to show the colossal arrogance embodied in the assertion that such a claim is "beyond the possibility of dispute"! Before the current series of bailouts and subsidies of companies "too big to fail" began, direct State control over the economy has in little over a century and a half gone from an insignificant proportion of less than 10% reported in the 1830s (see George Tucker, loc. cit.), to just under 40% in 2008 (see posting number III in this series). The current spate of bailouts and expansion of government further into the economy can reasonably be expected to expand this percentage and, with it, totalitarian control over the means by which people are permitted to exist.

The Federal Reserve was, in fact, never intended to control the money supply at all, but to regulate the currency and the banking system. Chiefly this was to ensure an adequate supply of credit for industry, commerce, and agriculture, while at the same time breaking the virtual monopoly of Wall Street over the supply of money and credit. The clear intent of the framers of the Federal Reserve Act of 1913 was that the private sector would continue to supply its own liquidity in the form of bills drawn on industrial, commercial, and agricultural assets, discounting them at commercial banks when necessary for a more liquid form of money.

If the commercial banks required more liquidity, the Federal Reserve would be there to rediscount such "qualified paper," thereby ensuring that there was always enough liquidity in the system, never too much, never an insufficiency. This would avoid the twin evils of inflation and deflation. The Federal Reserve was to supplement and regulate, not control, the money supply, which was presumed to be chiefly the purview of the private sector, over which the central bank would keep watch to prevent the kind of monopoly power over money and credit that caused the Panic of 1907. This had the potential not only to break up the concentration of control over money and credit that led to the Panic (see U.S. Congressional House Committee on Banking and Currency, Report of the Committee Appointed Pursuant to House Resolutions 429 and 504 to Investigate the Concentration of Control of Money and Credit, February 28, 1913. Washington, DC: U.S. Government Printing Office, 1913), but also free the United States forever from the "slavery of savings."

Thus, there is a desperate need to restore banking in general, and the Federal Reserve in particular to filling the special role that banks necessarily play in any economy that isn't permanently stagnant. By reorienting the economy along the lines of the Just Third Way, that is, in a manner consistent with the needs of the common good and the demands of human dignity, we can lower barriers and restore democratic access to bank credit, the chief means by which people acquire and possess private property in the means of production.

This requires that the commercial banking system and the operation of the central bank conform as fully as possible to the natural moral law — that is, a properly regulated financial system, and a money supply backed by the present value of existing and future marketable goods and services, not government debt. It also means that the central bank and the commercial banking system must operate in such a manner as to encourage widespread direct ownership of the means of production.

The obvious place to start, then, is to begin dismantling the apparatus that the federal government has imposed on the financial system and which has resulted in a phenomenal growth in State power as well as the concentration of ownership of the means of production in the private sector. That means the immediate cessation of the ability of the federal government to have the Federal Reserve monetize its deficits by buying and selling government debt paper through open market operations.

#30#