“Power Tends to Corrupt”

From 1824 to 1826, William Cobbett (1763-1835), whom G.K. Chesterton and others consider “the Apostle of Distributism,” published segments of A History of the Protestant Reformation in England and Ireland.  In the book, portions of which were later adapted for The Poor Man’s Friend (1829), Cobbett’s goal was not to defend the Catholic faith.  As he clearly stated, he was a Protestant, and never had any intention of being anything else.

Making the Best of a Bad Situation

As we saw in the previous posting on this subject, Charles Dickens’s character Ebenezer Scrooge turns out not to have been so much a bad man, but an incomplete person.  Once he accepted grace and “converted” to personalism, as Dickens put it, “He became as good a friend, as good a master, and as good a man, as the good old city knew, or any other good old city, town, or borough, in the good old world.”

Icarian Communism

Yes, communism.  Although later followers and modern commentators would refer to the system invented by Étienne Cabet as socialism, he insisted that it was communism.  To this day there is confusion regarding any meaningful distinction between the terms. 

Say’s Law: Balancing the Economy

In the previous posting on this subject, we looked at the concept of “productiveness,” that is, the idea that both labor and capital contribute to production as interdependent factors of production.  Further, the concept of productiveness includes the assumption that the ratio between the two can be measured.  Not that it is measured, just that it can be measured.

Keynes and the Slavery of Savings

     In the previous posting on this subject, we closed with the comment that John Maynard Keynes did not define savings properly, and this skewed his entire analysis to the point where it really wasn’t very closely connected with reality.  This is, in fact, why the eventual title of Louis Kelso’s third book was Two-Factor Theory: The Economics of Reality (1967).

Karl Marx, the Great Reductionist

A short time ago we got a request to comment on Karl Marx as “the second economic reductionist.”  In the context of the discussion this referred to the socialist movement which, to make a very long story short and oversimplify greatly, began in the early nineteenth century with Henri de Saint-Simon’s declaration in his posthumous book, Le Nouveau Christianisme (1825) that what would in a few years be known as “socialism” was “the New Christianity.”

Some Labor Problems

In the previous posting on this subject, we noted that where Adam Smith said a thing is worth what the customer is willing to pay for it, David Ricardo said a thing is worth the labor it cost to produce it combined with its scarcity.  We then asked the forbidden question, What if it takes immense labor to produce a unique item that nobody wants?  That’s where the “labor theory of value” gets more than a little dicey.

Rethinking Saving for Retirement

It’s a truism that has become engrained into American life.  Go to school to get good grades.  Get good grades to get a good job.  Get a good job to get a good pension for retirement.  Be sure to save enough on the side in an IRA or 401(k) to supplement your pension and Social Security so you can afford to do all the fun things you see other people doing on TV.

The Four Faces of Socialism: The Abolition of Private Ownership

As we saw in the first posting on this subject, there are four primary aspects of socialism.  These are philanthropy, communitarianism, reform or abolition of religion, and — our topic for today — the abolition of private ownership.  Again, it is important to note that a particular form of socialism may not include all or even any of these aspects, and yet still be true socialism.

The Four Faces of Socialism: The Essence of Socialism

No, this is not a discussion on the various types of socialism, such as Marxist, Georgist, Relgious, or Democratic (especially since there are many more than that), but on four key aspects of socialist thought itself.  We will have to look briefly at a couple of the different forms of socialism, but that is not the main point here.

Own the Fed, Part XIV: Happy Days

While often viewed as the highpoint (and hidebound) pinnacle of "traditional" American culture and civilization, the 1950s were actually a time of revolutionary upheaval, politically, culturally, and, especially, economically. When we talk about the decade of the fifties as revolutionary, however, we are not referring to the "lost" or the "beat" generations. Vocal as they were, these were only a fringe element that did not define American life or culture.

The true revolution of the 1950s was the fundamental change in the attitudes of ordinary people. The presumed ideal of the nuclear family with two point whatever children, Father Knows Best, a wage system job as the primary source of family income, a car in every garage and a chicken in every pot, were, despite the common opinion, very recent innovations. This is especially true of the idea of a wage system job firmly ensconced within a monolithic capitalist economy as the sole source of income for the family.

Much of this sea change came out of the New Deal and had been formalized by the demands of the war. We may — if we wish or if we find it useful — denigrate the narrow-mindedness and so on that presumably characterized life in the 1950s. Such comments and the endless analyses of that time from that standpoint, however, always seem to miss the most revolutionary change of all: the switch from independence to dependence as the predominant condition of the "typical" American.

The basic problem was that the financial system and the economy were and remain essentially socialist — if we define socialism correctly as the abolition of private property in the means of production. As Karl Marx quite accurately pointed out in The Communist Manifesto, the communist revolution did not depend on abolishing private property for ordinary working people. Capitalism had already done that by concentrating ownership of the means of production in a small private elite and forcing the great mass of people into the wage system.

What the communists proposed was to establish justice by taking ownership of the means of production away from that small private elite, and concentrating ownership even further in the hands of the State. For most people, the United States in the 1950s, although it was called "capitalist," was to all intents and purposes socialist. There was and remains little difference between capitalism and socialism for the typical wage worker.

Whether capitalist, socialist, or some variation on those two themes, largely as a result of the New Deal and the reorientation of the Federal Reserve to conform to the tenets of the Currency School, virtually everyone now looked to the State to solve all problems. The McCarthy hearings were shocking not only for the methodology used, but the fact that, all things considered, both "capitalists" and "communists" used the same techniques, depending on who was able to seize power. The end justified the means, and the justice of the end was now determined by whoever managed to control the State.

This new orientation and understanding of the role of the State was demonstrated most graphically by the "Accord" reached under President Truman between the United States Treasury and the Federal Reserve System. This 1951 agreement ostensibly restored the independence of the Federal Reserve, but this — as required by the dictates of Keynesian monetary and fiscal policy — was independence in name only.

In addition to the essentially meaningless Accord between the Treasury and the Federal Reserve, however, a critical piece of legislation was passed to curtail certain abuses that continued to afflict the financial system. Bank holding companies were being used to circumvent prohibitions that had been implemented after the Panic of 1907 to prevent banks from owning non-banking businesses. There were also problems with bank holding companies acquiring banks and non-banking businesses across state lines.

To stop these abuses, Congress passed the Bank Holding Company Act of 1956 (12 U.S.C. § 1841, et seq.) to regulate bank holding companies. Bank holding companies had not been specified in previous legislation. Under the provisions of the new Act, the Federal Reserve Board of Governors now had to approve the establishment of any bank holding company. No bank holding company in one state could acquire a bank in another state. Bank holding companies were prohibited from engaging in virtually all non-banking activities, or from acquiring voting shares of certain types of non-bank businesses.

Despite the ineffectual nature of the Accord and the necessity of the Bank Holding Company Act, the basic system remained the same. While certain abuses might have been curtailed and the nominal independence of the Federal Reserve was presumably secure, nothing really changed for the average person. Perhaps helping to obscure the underlying problems with the economy and the financial system was the link established between the danger of foreign domination and socialism. The dangers of both were quite real and immediate. Many people, however, were apparently convinced that socialism and capitalism were somehow fundamentally different, and that "capitalism," "free market," "freedom," and "democracy" were somehow synonymous.

In 1958, however, Louis Kelso and Mortimer Adler published what may yet be recognized as one of the most genuinely revolutionary treatises of the 20th century, the misleadingly titled, The Capitalist Manifesto. The book's title as well as the subtitle were virtually guaranteed to appeal to newly dependent Americans of the 1950s given the widespread virtual obsession with communism and yet, at the same time, help shake them out of their complacency. As the subtitle expressed the purpose of the book, "A revolutionary plan for a capitalistic distribution of wealthy — to preserve our free society." [Emphasis in the original.]

By "capitalism," Kelso and Adler meant an economic system in which capital, not human labor, is the predominant factor of production, not the more accepted definition of an economic system characterized by ownership of the means of production concentrated in the hands of a relatively small private elite instead of in the State. The notion that the plan would preserve rather than restore the presumably free society of the United States was also somewhat problematical — but authors don't usually sell books or convince people of a course of action by insulting them. If Americans believed themselves to be free people instead of economic dependents of the State and central bank, then so be it . . . as long as they listened.

Somewhat surprisingly, many people did listen. The book became a best seller. As Kelso's ideas took hold and began to gain popularity (Adler described his contribution as tying Kelso's economic ideas in to the dignity of the human person exhibited in political democracy), prominent economists with a stake in the current system such as Paul Samuelson and Milton Friedman felt compelled to ridicule the proposals. Both Nobel Laureates, however, stopped there, and did not offer any substantive critiques of the Kelso ideas. They preferred to state dogmatically (Friedman's actual word choice) that they rejected what became known as "binary economics" without having to give reasons.

In this blog series we have discovered that Keynesians and Monetarists (as well as Austrians) base their economic theories on the tenets of the Currency School. It thus appears that the reason, e.g., Drs. Samuelson and Friedman refused to debate the issues was that they were not prepared to deal with or even understand a system based on the tenets of the Banking School, especially the real bills doctrine and Say's Law of Markets. They committed what amounts to the ultimate intellectual crime of judging another system not on the soundness of the principles of that other system, but on their own principles — in essence, blaming black for not being white, or vice versa. The popularity of this technique in nearly all fields of thought does not, however, lend it any degree of legitimacy. As G. K. Chesterton explains,

It is no good to tell an atheist that he is an atheist; or to charge a denier of immortality with the infamy of denying it; or to imagine that one can force an opponent to admit he is wrong, by proving that he is wrong on somebody else's principles, but not on his own. After the great example of St. Thomas, the principle stands, or ought always to have stood established; that we must either not argue with a man at all, or we must argue on his grounds and not ours. (The Dumb Ox, 95.)

This brings in how, exactly, the views of Friedman and Samuelson differ from those of Kelso with respect to the role of the central bank and, more broadly, that of the State itself. For both Keynesians and Monetarists the Federal Reserve System is, ultimately, a mere money machine for the federal government, generating funds through open market operations dealing in government securities. For an adherent of the Currency School, the central bank is not an institution designed and intended to provide the private sector with adequate liquidity by rediscounting commercial paper. The only issues that concern Keynesians, Monetarists, and Austrians are how best to operate that machine responsibly, and what principles are to guide the creation of new money so as — depending on your orientation — to increase, limit, or eliminate the power of the State.

Obviously the problem is that both Keynesians and Monetarists fail to address the real issue: the economic disenfranchisement of the ordinary person by the erection and maintenance of barriers to widespread ownership of the means of production. State control of the economy is a given, whether explicit as in Keynesianism, or implicit as in Monetarism and the Austrian schools. If any doubt remains on this point, ask a Keynesian, Monetarist, or Austrian how he or she defines 1) money and 2) private property, and how money and private property are linked, if at all.

For Kelso, private property — the chief support for human dignity — is the basis for any workable system, political or economic. Political and economic principles must be integrated consistently without distortion, with the goal of building political democracy on a solid foundation of economic democracy. Thus, respect for each individual's life, liberty, property and pursuit of happiness must not only be paid lip service, but be incorporated into the legal systems and institutional structures of society at all levels. Securing each person's natural rights and protecting them by ensuring democratic access to the means of acquiring and possessing private property in the means of production is, as Kelso and Adler claimed, a more effective counter to communism than government regulation or McCarthyism.

Presenting such ideas to Americans who had so recently been forced into a condition of dependency — wage slavery (not a Marxist, but an Aristotelian concept, as Adler explained) — was something of a problem. In The Capitalist Manifesto, Kelso and Adler make the moral, economic, and political case for widespread direct ownership of the means of production, thereby laying the groundwork for what the Center for Economic and Social Justice would distill as the four pillars of an economically just society:

1. Limited economic role for the State,

2. Free and open markets as the best means for determining just wages, just prices, and just profits,

3. Restoration of the rights of private property, especially in corporate equity, and (the "fatal omission" from both capitalism and socialism)

4. Widespread direct ownership of the means of production.

Kelso and Adler also dealt with another very serious problem. The economic disenfranchisement of the great mass of people noted by Grosscup early in the 20th century had advanced in tandem with a diminished understanding of private property and, of course, those institutions derived from private property, particularly money and credit, to say nothing of the control over one's own life that property confers. In March 1957, the year prior to the publication of The Capitalist Manifesto, Kelso published "Karl Marx: The Almost Capitalist" in the American Bar Association Journal. In part, the article targeted the wide misunderstanding of property and its importance in the political and economic order. In a few brief sentences Kelso detailed an understanding of property that all economists and lawyers should keep in mind when tempted to interfere with basic human rights to achieve some transitory or politically expedient good:

It may be helpful to take note of what the concept "property" means in law and economics. It is an aggregate of the rights, powers and privileges, recognized by the laws of the nation, which an individual may possess with respect to various objects. Property is not the object owned, but the sum total of the "rights" which an individual may "own" in such an object. These in general include the rights of (1) possessing, (2) excluding others, (3) disposing or transferring, (4) using, (5) enjoying the fruits, profits, product or increase, and (6) of destroying or injuring, if the owner so desires. In a civilized society, these rights are only as effective as the laws which provide for their enforcement. The English common law, adopted into the fabric of American law, recognizes that the rights of property are subject to the limitations that

(1) things owned may not be so used as to injure others or the property of others, and

(2) that they may not be used in ways contrary to the general welfare of the people as a whole. From this definition of private property, a purely functional and practical understanding of the nature of property becomes clear.

Property in everyday life, is the right of control.

The main problem facing Kelso was that, under the mercantilist assumptions of the Currency School — and keep in mind that the tenets of the Currency School are the cornerstone of all mainstream schools of economic thought, especially the dogmatic belief that capital formation can only be financed out of existing accumulations of savings — ownership of the means of production must be concentrated to finance new capital formation.

This "slavery" to existing accumulations of savings results necessarily in mainstream economics rejecting the real bills doctrine and Say's Law of Markets. This is true if for no other reason that both the real bills doctrine and Say's Law are built on the assumption that "money" is a derivative of the present value of existing or future marketable goods and services. This assumption (or, more accurately, an observation of reality) undermines the absolute dogmatism of the presumed necessity of existing accumulations of savings to finance new capital formation.

Eliminating our dependency on existing accumulations of savings as the source of financing new capital formation changes our understanding of the proper role of a central bank, especially the Federal Reserve System. In its original conception, the Federal Reserve, by its mandate to provide an elastic currency for qualified industrial, commercial, and agricultural investment, had the potential to provide every citizen with access (through the commercial banking system) to the means of acquiring and possessing private property in the means of production.

This power was gradually whittled away in response to demands of political expedience and the shift in mainstream economics away from the principles of the Banking School. The result is that the Federal Reserve has been transformed from the chief vehicle for managing a sound and stable currency for private sector development, into a means whereby the State is able to manipulate the currency for political ends and to implement fundamentally unsound economic policy in furtherance of those ends.

Emancipating humanity from the "slavery of savings" that had forced a condition of dependency on a people presumed to be the most free on earth was, ultimately, the point of Kelso's work. This inherent respect for the dignity of the human person is the reason why Adler found Kelso's ideas to be, in his opinion, one of the most important contributions to human thought in the 20th century.

Once the economic system has been freed from the slavery of savings — that is, the assumption that only existing accumulations of savings can be used to finance capital formation — the rest is relatively simple, although convincing policymakers of its rightness and utility would take another fifteen years. Even then, the "victory" was only partial. The system remains oriented in conformity with the principles of the Currency School, and academic economists and policymakers are still enslaved to past savings.

The mechanism Kelso invented to implement his theories was the "Employee Stock Ownership Plan," or "ESOP." Many people even today assume that Kelso first invented the ESOP, and then developed the theories that became known as binary economics to support his invention. This is incorrect. Kelso first developed the theories, then applied them more or less consistently.

The immediate question, of course, was how workers without savings and without existing ownership stakes could become part owners of the companies that employed them. As the bulk of production shifts to capital from labor, the market value of human labor (though, of course, not human beings) declines relative to capital. At that point, it becomes necessary to supplement and, in some cases replace labor income (wages/salaries) with ownership income (dividends/profits), just as Morrison observed in 1854. Without accumulated savings to use to purchase capital outright, or existing ownership of wealth to use as collateral, however, how can propertyless workers (and, eventually, everyone) become owners of capital?

The answer: through the application of the real bills doctrine and Say's Law of Markets. A company has a present value based on the anticipated future stream of profits to be generated by the production of marketable goods and services. Workers can purchase this present value on credit, and repay the acquisition loan out of future profits realized from the sale of marketable goods and services. The ESOP was designed to facilitate worker ownership on these terms.

Specifically, an ESOP is an expanded ownership mechanism "qualified" as a "defined contribution plan" under U.S. retirement law. That is, a participant in an ESOP is entitled to the value of his or her total vested benefit in the Plan, but nothing more. This is in contrast to a "defined benefit plan" in which a participant is entitled to a fixed ("defined") benefit whether or not the retirement trust has the funds. By its nature, an ESOP cannot go bankrupt, even if the sponsoring company goes under, where a standard defined benefit plan can go — and, in these days, frequently has gone — bankrupt, even driving the sponsoring company into bankruptcy due to underfunding of its pension liability.

The ESOP is a trust that can borrow on behalf of workers as a group to acquire ownership of the employer company, repayable with pre-tax profits or dividends. In current law, ESOPs can be either leveraged (designed to borrow to acquire company shares) or unleveraged (the shares are contributed by the employer). Typically an ESOP does not require workers to use their own savings or wages to acquire their shares, or to pledge their personal assets as collateral in a leveraged transaction.

In an ideal world, or at least a world in which the central bank had not been diverted into being the chief financing source for the State instead of the primary manager of the money supply for the private sector, a financing and ownership vehicle like the ESOP would have taken the world by storm immediately. As it was, it very nearly did, but it took a decade and a half to get the process started, and still remains today only a small start on the effort to make the economy run for the benefit of everyone, not just a select few.

#30#

Own the Fed, Part V: The Crisis of 1920

With the end of World War I, the United States faced a series of problems that threatened to destabilize the economy. Admittedly, the depression that followed the end of the war did not last very long — even though a different, less restrictive definition of the dreaded D word was in use. By April 1919, there was an upswing in business, the economy having been given the chance to switch back to peacetime production after the demands of the war. As the existing accumulations of savings had been drained off by the Liberty Loan drives and, after the war, the Victory Loan drive, commercial banks turned to the Federal Reserve to provide an adequate money supply, as intended by the framers of the Act and as provided for in the design of the institution.

Unfortunately, much of the demand the commercial banks experienced for additional liquidity did not come from qualified industrial, commercial, and agricultural investment. As is usually the case in a period of business expansion, there was also a great increase in speculation on the secondary market. This caused commercial banks to extend credit and create money for speculation, diverting their resources (necessarily limited by the fractional reserve requirement) away from productive investment. The increased demand for money and credit for speculative purposes was, in fact, a significant part of the increased pressure for the Federal Reserve to provide additional liquidity to the private sector. (Financial Organization and the Economic System, op. cit., 392.)

That, of course, was impossible. Out of the fear that the money creation powers of the system would be diverted to just the sort of non-productive speculation that had led to the Panic of 1907, the Federal Reserve Act of 1913 clearly specified that bills drawn on equity issuances would not qualify for rediscounting. (H.R. 7837, § 13.) The Federal Reserve could, of course, rediscount qualified paper issued by the commercial banks. There was, effectively, an unlimited supply of credit for productive purposes, but hat would not have satisfied speculative demand.

Adding to the problem was the fact that during the war any company that had not been able to demonstrate that the goods and services it produced were essential to the war effort had, in general, not been able to obtain loans to finance capital expansion. This was due principally to restrictive legislation as well as the efforts of the Capital Issues Committee. During the latter part of the war, the Committee had managed to prevent the flotation of any securities that were not deemed necessary for prosecuting the war. With the Armistice, however, and the removal of the restrictions, a phenomenal number of new loans were made.

Another factor was the depletion of the remaining reserves in the system by the demands of the trade imbalance with the Orient and South America. Despite the name, "World War," the Orient and South America, by and large, had not been directly engaged in the conflict. There had been some sporadic efforts in Africa, disastrous for both sides in the conflict, but, except for the Japanese six-day siege of Tsingtao in China, and minor engagements at Bita Paka and Toma in German New Guinea, the war in the Pacific was nearly bloodless, while South America's direct involvement primarily dealt with the seizure of German warships in neutral ports that had overstayed the 24-hour limit.

This meant that the productive capacity of the Orient and South America for consumer goods was intact, and had not changed over to war production to any significant degree. Raw materials were a different story. The demand for nitrates and other raw materials shrank considerably with peace, causing widespread unemployment, especially in Chile. A large number of the unemployed workers joined communist organizations. Some authorities credit this with beginning the spread of Marxism on the continent.

In any event, with the domestic restriction of non-war related production, if the United States wanted consumer goods, a large amount of those goods had to be imported. Consequently there was a large outflow of gold reserves from the United States to South America and the Orient as "boot" in unequal exchanges and to fund a growing trade deficit. The United States was not producing anything the Orient and South America wanted in any quantity — war material having a somewhat limited market — so, instead of exchanging commodities and finished goods, the United States had to pay in gold. Under the fractional reserve banking mandated by partial adherence to the tenets of the Currency School, for every dollar in gold transferred to a foreign country, the domestic money supply was potentially reduced by approximately twenty dollars. In the United States financial system as a whole, reserve requirements in gold amounted to approximately 5% of outstanding claims against cash. (Harold Moulton, Financial Organization and the Economic System, op. cit., 392.)

As a result, reserve ratios across the country declined. Recall that, in contrast to today's artificial redefinition that restricts "reserves" to mean cash, demand deposits at the Federal Reserve, and, effectively, government securities, under the original Federal Reserve Act of 1913, "reserves" included qualified industrial, commercial, and agricultural paper as well as gold. Ratios declined from the recommended level of approximately 50% to less than 45% by the end of 1919.

The decline in reserves raised an issue that had plagued the United States for decades in the debate over whether or not a central bank should be established. A central bank is, by theory and practice, intended to establish and maintain a stable currency by regulating the supply of money and credit to the private sector directly primarily by rediscounting qualified paper and supplemented with open market operations to ensure that no money is created that is not backed by hard assets in the form of the present value of existing or future marketable goods and services. The problem was that, using a confused definition of reserves and misunderstanding the meaning and role of interest, the amount of gold in the system could decline to the point where it was insufficient to cover the demand for convertibility into specie.

The obvious solution was to suspend convertibility domestically and encourage the rediscounting of loans made for qualified industrial, commercial, and agricultural purposes. The outflow of gold would then have made little difference, and the trade imbalance would have been corrected by increased exports as American industry, commerce, and agriculture became productive once again. By using a definition of reserves that excluded such qualified paper, and the enormous increase in money creation for speculation instead of productive purposes, however, the country found itself in serious difficulties.

Unfortunately, business leaders and policymakers at the time were in a self-imposed "Catch-22" situation. There was an apparent business "boom," but it was largely speculative, not true investment in sound capital projects. The country needed to rebuild its peacetime capacity to produce marketable goods and services, a policy that would have the added benefit of reversing the drain of gold out of the country and thus replenishing commercial bank reserves. This called for a low discount rate at the Federal Reserve to encourage productive investment. With financial resources of commercial banks diverted into speculative projects, however, it seemed as if the economy was fast becoming, in today's terminology, "overheated." Authorities contended that the need was for the Federal Reserve to raise the discount rate.

The federal government, however, was initiating the process of floating its "Victory Loan" issue of $4.5 billion. The Treasury Department needed to keep the interest rate on the bonds as low as possible to keep costs down for the taxpayer. This appeared to mandate a low discount rate. Further, the Treasury Department had already announced that the interest rate on the Victory Loan would be low, and bankers throughout the country had set policies and made loans based on that assumption. To raise the interest rate would have meant breaking faith with the bankers, and cause them substantial losses. The interest rate was kept low.

Commercial banks did not, however, return the favor. Bankers found it much more profitable to make new loans for speculative purposes out of existing accumulations of savings and by creating money by discounting, than to extend loans for properly vetted industrial, commercial, and agricultural investment that qualified for rediscounting at the Federal Reserve. The interest rate on qualified loans was kept down due to the low discount rate and the low risk typically associated with blue chip securities, thereby lowering potential profits. The profit potential on loans made for speculative purposes was much greater due to 1) no fee paid to the Federal Reserve for rediscounting unqualified paper, 2) the higher interest rate typically charged for lending existing accumulations of savings, and 3) the high risk premium associated with speculative loans.

What authorities even today fail to realize is that raising the discount rate made no difference. The discount rate did not, and does not apply to "notes, drafts, or bills covering merely investments or issued or drawn for the purpose of carrying or trading in stocks, bonds, or other investment securities." (H.R. 7837, § 13.) Regardless of the discount rate, commercial banks would have gone on creating money through their own discount powers, not rediscounting "notes, drafts, or bills" that didn't qualify for rediscounting in any event, and pocketing the huge profits that result when speculation is successful.

Ironically, the only thing in the system providing a check on the creation of money for speculative purposes was the fractional reserve requirement. Commercial banks had to make a certain percentage of genuinely productive loans (that counted as reserves) to increase their reserves in order to make the speculative loans (which did not count as reserves). A 100% reserve requirement that included notes, drafts, and bills drawn for trading in properly vetted and collateralized investment in stocks, bonds, and other securities in the definition of reserves that qualified for rediscounting would have solved the problem, but rediscounting such securities was specifically prohibited by the Federal Reserve Act. The Federal Reserve therefore had no power to affect the dealings of commercial banks in speculative securities except indirectly by manipulating reserve requirements and the interest rate — which (as history has demonstrated) has a tendency to backfire and inhibit or prevent productive investment and, paradoxically, promote speculative and unsound lending in the hope of making large profits to make up for the paucity or reduced attractiveness of financially feasible sound investment.

In addition to the decline in the trade balance already mentioned, two other factors contributed to the seriousness of the situation. One, the rail system was disrupted. This caused the transportation system to break down and, eventually, led to the Great Railroad Strike of 1922. Businesses could not get raw materials or move their finished goods, and had to obtain extended credit to cover them until normal operations could resume. Moulton commented that this led to a new term, "frozen credit," to describe the situation in which businesses had to secure credit for longer periods and for greater amounts than would otherwise have been the case. (Financial Organization and the Economic System, op. cit., 395.)

Two, the inflation induced by the decision to finance the war by borrowing rather than by taxation was having its effect. As Moulton explained the situation,

The steady rise in commodity prices during 1919 and the first months of 1920, accompanied as it now was by substantial increases in rents, had finally reached a point where it was forcing a curtailment of consumptive demand. Whatever may have been the case earlier, it had by this time certainly become true that the net annual wages of labor, generally speaking, as well as the income of the salaried classes, were failing to keep pace with advancing prices, with the result that the real purchasing power of the rank and file of the people declined. The "peak" of prices was reached in the spring of 1920, among other reasons because consumptive demand was not sufficient to absorb the existing volume of production at the prices for which goods were then being offered. Popular hostility to the continuous marking up of prices is also believed by many to have finally led to a voluntary reduction of purchases. (Ibid.)

The suicidal solution of increasing consumer credit to stimulate the economy was not considered anything other than insane, as the tremendous number of contemporary articles about "dollar-a-day slavery" in the form of loan sharking attest. To try and maintain some control over the situation and stabilize the economy, then, the Federal Reserve issued an official warning in the early summer of 1919. Commercial banks and Wall Street speculators were informed that it was necessary to curtail loans made for speculative purposes, especially when loans were extended for speculative purposes at the expense of truly productive loans extended to finance capital formation.

The warning was ignored. It wasn't until the middle of October and the situation had become extremely serious that the Federal Reserve repeated its warning. The situation was so bad by then that the banks in New York actively cooperated with the Federal Reserve Board. The commercial banks drastically raised the rates on call money (i.e., loans made for purchases on the margin) and put a cap on the amount that brokers could borrow. As a result, stock values collapsed. This ended the bull market that had been in effect since the spring.

While the restrictions on speculation caused a significant drop in the stock market, this did not have a material effect outside Wall Street. Most people did not have equity investments, and did not, in general, engage in speculation. Curtailing speculation halted the diversion of financial capital and lending capacity from productive purposes, and damped down some of the inflationary pressure on the economy, but it did not eliminate it. The price level was still higher than either the productive capacity or the consumptive capacity of the economy could justify.

Consistent with the thinking of the day, and repeating the policy that had appeared successful following the Civil War, still in living memory, the solution to inflation seemed obvious. To counter the inflation caused by government borrowing and the creation of money for non-productive purposes, induce deflation, or a constriction of the money supply.

Deflation, however, causes its own problems, not the least of which is that a policy of tight money tends to affect the productive sector adversely. This is particularly true for any business (including farms) that borrowed "cheap money" during the inflationary period, and has to repay the loan with expensive money. Induced deflation usually leaves the prime causes of inflation — government borrowing and private speculation — untouched, and can even, in certain circumstances, encourage massive non-productive money creation.

This is because creating money for productive purposes, per the real bills doctrine of the Banking School, is non-inflationary. It makes no sense to deprive industry, commerce, and agriculture of financing to “cure” inflation. In periods of deflation and falling prices, however, speculation tends to run rampant as even people who would not otherwise have engaged in speculation are drawn by necessity or greed to the prospect of high, if extremely risky profits. This was the case especially in the latter half of the 19th century, when the United States tried to correct the financial folly of Salmon Chase in borrowing to finance the Civil War with the counter-folly of deflating the currency. Further, the State, unable to derive sufficient revenue from a declining tax base in deflationary periods, frequently resorts to additional borrowing, countering the deflation with additional inflation by creating money backed by government debt, making a policy of deflation self-defeating.

Despite the faulty logic, the Federal Reserve began raising the discount rate. It had no effect except to raise the costs of doing business, and fortunately did not cause the expected deflation. Because of the high price level, businesses were able to generate sufficient profits to make borrowing even at high interest rates pay. As Moulton described the situation,

The several increases in interest rates that were made during the autumn and winter of 1919-1920 apparently had little, if any, effect in restraining business activity. Before an outright curtailment of loans was undertaken, the other factors to which reference has been made — transportation difficulties, rising living costs, a restriction of consumption, and falling prices of raw materials, etc. — were operating to bring about a price and business readjustment. (Financial Organization and the Economic System, op. cit., 396.)

The bottom line to the Crisis of 1920 was that the Federal Reserve can be given credit for staving off what had the potential to be a financial meltdown. This would not have been anywhere near the scale of what was going on in Germany and Austria-Hungary at the same time, but it would have been extremely serious, as the events of ten years later were to prove.

What puzzles the economists and policymakers, however, is that the Federal Reserve, at one and the same time, both caused the crisis, and remedied it — even though the remedy could not have worked in any event, and was not implemented in any effective manner. The inflation was caused in large measure by the decision to finance the war through borrowing rather than taxation, while the proposed deflation would have wrecked the economy. How, then, did the Federal Reserve resolve the crisis? Through public confidence in the Federal Reserve itself, an intangible that, as Charles Morrison explained in 1854 in his Essay on the Relations Between Labour and Capital, has the power to keep an economy on an even keel. As Moulton explained,

The Federal Reserve system, however, undoubtedly prevented a panic in 1920. Beginning about the middle of May, the credit tension became of the acute variety that had in the past characterized the weeks immediately preceding a financial collapse. Just as soon as the decline in prices, with the concurrent slackening of industry and backing up of the speculative water, began, great numbers of businessmen were panic stricken much as would have been the case in former times. The cancellation of business orders, the failure of creditors to meet their obligations promptly, the recurring slumps in inventory values, and the uncertainty as to the whole future trend of events developed a veritable business crisis — accompanied by the usual insistent pressure upon the banks for loans with which to tide over the interval of readjustment. There was one noteworthy difference, however, between this and similar occasions in the past. Widespread confidence in the Federal Reserve system proved a powerful sedative. There was no panic and no suspension of specie payments. (Financial Organization and the Economic System, op. cit., 396.)

Thus, even though the Federal Reserve had done the wrong thing by allowing itself to be diverted from its primary mission in order to finance the war, and even though the proposed remedy of induced deflation would have been disastrous, the very fact that the Federal Reserve existed and was doing something restored public confidence and averted a financial meltdown. Unfortunately, it also convinced economists and policymakers that inducing inflation or deflation, as well as manipulating reserve requirements and interest rates were effective tools in controlling the economy, as opposed to setting the standard of value, regulating the currency, and maintaining its stability, as is a proper role of the State, and thus delegated to the Federal Reserve.

#30#

Own the Fed, Part IV: Henry Ford and John Maynard Keynes

The year 1919 was a watershed for the American economy, and thus critical in how the mission of the Federal Reserve System changed so profoundly from providing liquidity directly to the private sector by rediscounting commercial paper, to being the chief financing vehicle for government and indirectly affecting the money supply by manipulating interest rates. Two seemingly unrelated events in that year affected popular perceptions of money, credit, banking, finance, and — most significantly — the institution of private property from which these institutions are derived, to say nothing of the change in the perception of the proper role of the State. The first was one of the most significant, if little understood lawsuits in American history. The second was the beginning of the career of the most influential economist of the 20th century. The lawsuit was Dodge v. Ford Motor Company (204 Mich. 459, 170 N.W. 668. (Mich. 1919)). The economist was John Maynard Keynes.

Of the two, the lawsuit may have caused the most damage. The issues involved struck at the architecture of the social order: the legal system that — presumably — defines and protects each person's natural rights to life, liberty (freedom of association), property, and pursuit of happiness (the acquisition and development of virtue), and in theory restricts the role of the State to the common, not each person’s individual good. Economists, for all their theorizing, ultimately have to deal with the formal structures of society that, in significant measure, define the market and the role of the State in the economy. Had not the legal system already accepted the tenets of the mercantilist Currency School that underpins Keynes's theories and undermines the institution of private property and gives too great a role to the State, Keynes could have theorized to his heart's content and never achieved more than a few ripples in the relatively small pond of academia.

It seems not only a paradox, but an astounding contradiction to claim that Henry Ford was a prime mover in the virtual destruction of private property for the great mass of people not only in the United States, but throughout the world. It might not be too much of an exaggeration to say that Ford did more to abolish private property in the means of production as a widespread institution than anything Karl Marx, the Currency School, or Keynes managed to accomplish.

This comes across as almost heretical, for Ford epitomized American Capitalism the way Thomas Edison was the exemplar of American Ingenuity. The hold that these two men had on the American psyche was such that when the novelist Garrett P. Serviss wrote a sequel to H. G. Wells's War of the Worlds (1898) in which humanity took revenge for the alien invasion of Earth, he titled it, Edison's Conquest of Mars (1898). Nevertheless, Henry Ford, the virtual "high priest" of capitalism, was responsible for undermining the very system to which he credited his success. This is consistent with the remark attributed to Karl Marx, "The last capitalist we hang shall be the one who sold us the rope."

The story begins in January of 1914 (if not earlier with the formation of his character and attitudes) when Ford decided to raise the basic wage rate at the Ford Motor Company from $2.34 per day to $5.00. (Robert Lacey, Ford, The Man and the Machine, 1986.) Initially the raise was limited to certain classes of machinists and widows with children. Ford, of course, was actuated by the best of motives. He seems to have honestly believed that he was a public benefactor.

Not unexpectedly, the increase caused so much envy among all workers that Ford was forced to make $5.00 the basic minimum across the board. Workers employed at other auto plants and unemployed people from across the country descended on Ford in search of jobs. This caused riots. A number of small businesses located near the Ford plant were destroyed during the disturbances.

Other auto manufacturers were forced to raise their pay rates to keep qualified workers. The increase in pay unlinked to increases in productivity started an inflationary wage/price spiral that has lasted to the present day and is, in part, responsible for the current condition of the American automobile industry. Exacerbated by the inflationary monetary policies instituted in the First World War caused by using the new Federal Reserve System to finance the war, Ford's unilateral wage increase eventually resulted in a typical autoworker in 2009 making in wages and benefits more than twice in one hour what an autoworker made in 1909 in an entire week — Saturdays included.

Henry Ford had the opportunity in 1914 to spread ownership out among his workers. This would have shifted the practice of raising pay by relying on increasing fixed wages and benefits, to variable profit sharing from the bottom line. Instead, Ford's actions had the effect not only of locking his workers permanently into the wage system and shutting them out of almost any chance of becoming owners of even a small capital stake, but of convincing most Americans that the wage system is the only system. Then, five years later, in an effort to protect his own private property interest, Ford virtually destroyed private property itself with the concurrence of the courts.

Possibly because he mistrusted banks (which he appears to have believed were controlled by an international Jewish cabal), Ford decided to finance a plant expansion using retained earnings instead of selling new equity or borrowing the money. Some of the minority owners (i.e., owners with less than a controlling interest), the Dodge brothers, protested. They weren't interested in why Henry Ford refused to borrow from banks or issue new shares to finance plant expansion. They wanted the dividends to which they were entitled under the traditional rights of private property. Henry Ford refused to pay dividends, and the Dodge brothers sued.

The case, Dodge v. Ford Motor Company, became a landmark. Among other issues, the court redefined the traditional right to receive the "fruits of ownership" (i.e., income from what is owned — dividends) for minority shareholders as limited to receiving dividends only if the distribution wouldn't harm the company (the "Business Judgment Rule"), and to sell their shares if they weren't happy with the dividend policy of the majority owner(s).

The court ruled, in effect, that minority shareholders are able to enjoy their full "fruits of ownership," including the right to receive any and all income generated by what is owned, only if the majority owner so agrees. That is, the majority owner(s) in the person of the Chairman of the corporate Board of Directors alone has the right to set dividend policy for a company, and does not need the consent of a minority owner or owner(s) to withhold that which belongs to the minority owner(s) by natural right if, in the judgment of the Board of Directors, the distribution of dividends would harm the company.

Thus, according to the Michigan Supreme Court, someone who owns less than 50% of an asset doesn't really own it in the full sense of the term. Anyone who owns more than 50% of that same asset can withhold some or all of the rights of ownership from the minority owner or owners, especially the right to enjoy the income generated by the asset, at his or her discretion.  Ironically, the Michigan Supreme Court ordered Henry Ford to pay out a special dividend totaling in the millions because he had not proved his case that it was in the best interests of the shareholders that cash be accumulated in the company.

Thus, it was not the fact that Ford had refused to pay dividends that mattered, but that he had refused to pay dividends when there was an obvious surplus, and he could not prove that payment of dividends would harm the company.  Had Ford been able to "prove" that payment of the special dividend would, in his judgment, harm the company by depriving it of funds presumably required for growth (the usual argument made — and accepted — today in the belief that savings must be accumulated before forming capital), he could have withheld any and all dividends.

The decision by the Michigan Supreme Court thereby redefined what it means to be an owner by shifting the burden of proof whether the refusal to pay dividends violated shareholder rights.  Boards of Directors did not have to justify non-payment of dividends.  Instead, the shareholders had to prove that the refusal to pay dividends would not harm the company — and, logically, it is impossible to prove a negative. This struck directly at what has long been considered an inalienable right and the foundation of civil society itself — to say nothing of being the basis of the real bills doctrine that provides the theoretical basis for central banking.

Unfortunately, many commentators have obscured the true import of the ruling by focusing on a relatively minor issue that was raised as part of the plaintiffs' case. This was whether Henry Ford had the right to lower the price of Ford automobiles in order to increase sales, accumulate cash, and keep as many people as possible employed — and lower corporate earnings. As Ford had declared in a newspaper interview three years previously, "My ambition is to employ still more men, to spread the benefits of this industrial system to the greatest possible number, to help them build up their lives and their homes. To do this we are putting the greatest share of our profits back in the business." (Interview in The Detroit News, August 31, 1916.)

The court agreed that a corporation was not to be run as a charitable enterprise, but for the benefit of the shareholders. Most conventional analyses of the case stop at this point, without realizing the import of the fact that Henry Ford did not base his defense on his stated ambition to be a public benefactor by creating jobs, but on the "business judgment rule." Thus, if the individual elected by the shareholders (who happened to be Henry Ford, as he retained the majority block of shares) decided it was in the best interests of the company — and therefore the shareholders — to stop payment of dividends and deprive minority shareholders of their rights, the minority shareholders had to take whatever the majority owner(s) chose to dish out.

The alternative was to exercise their "take-it-or-leave-it" right to sell their shares and wash their hands of the whole business — in other words, exercise their property rights to become non-owners. In effect, Henry Ford claimed that he was protecting the best interests of the shareholders by depriving them of the exercise of their natural rights, that is, by treating them as less than human.  While Henry Ford failed to prove his case, subsequent generations of boards of directors learned the lesson, and (bolstered by widespread acceptance of the erroneous belief that new capital can only be financed out of existing savings) have no difficulty in persuading the courts that it would harm both the company and the economy as a whole to pay dividends.

What is also frequently ignored in analyses of the case is the fact that Henry Ford had dismissed another right of private property, that of control. He had previously blocked every effort of the minority shareholders to have input into decisions and exercise some degree of control over the business, such as design improvements and marketing strategy. This was particularly egregious with respect to the Dodge brothers, who owned the next largest block of shares (10%) after Henry Ford, and who were increasingly unhappy with Ford's dictatorial actions.

Consequently, prior to their lawsuit over Ford's restriction of dividend payments, the Dodge brothers began setting up their own automobile manufacturing company in secret, using their Ford dividends to finance the effort. Ford got wind of this and began withholding dividends. Ford was also suspected of wanting to reduce the price of Ford automobiles as a way of justifying the proposed reduction in dividend payouts and reducing the company value per share to make even selling the shares less profitable to the Dodge brothers.

After the Michigan Supreme Court ruled against him, Ford threatened to set up another rival automobile manufacturing company, probably to be wholly owned by Ford personally, apparently as a way to compel the Dodge brothers to sell their shares back to the Ford Motor Company at the reduced value per share that Ford had manipulated. In this he was successful — and thereby undermined another right of private property, that of disposal, by taking away the Dodge brothers' free choice in the matter of whether or not to sell their shares.

It was, however, a Pyrrhic victory. The Dodge brothers used the proceeds of the forced sale to complete setting up their own automobile manufacturing company. They soon designed and marketed an automobile that many car enthusiasts still consider one of the best popular vehicles ever built, the 1926 Dodge. This made the venerable Model T Ford, the basic design of which Henry Ford had resisted changing for twenty years (1908-1927), obsolete. Henry Ford was forced to invest vast sums in developing a competitor to the Dodge product, and to spend millions more retooling his factories to produce the Model A in 1928. His refusal to share power and reluctance to pay dividends to minority shareholders cost Henry Ford a huge fortune, and ensured that his company lost its position as the world's leading automobile manufacturer.

The contribution of John Maynard Keynes to Henry Ford's accomplishment was to legitimize it by offering a theoretical basis to justify the abolition of private property and the undermining of the free market — and thus the negation of the private sector role of the Federal Reserve and the glorification of the State. In 1919 Keynes published the book that established his reputation as one of the leading economists in the world: The Economic Consequences of the Peace. Just as Karl Marx summarized the theory of communism in a single sentence, "The abolition of private property" (The Communist Manifesto, 1848), Keynes encapsulated his school of economic thought by declaring: "The immense accumulations of fixed capital which, to the great benefit of mankind, were built up during the half century before the war, could never have come about in a Society where wealth was divided equitably." (The Economic Consequences of the Peace, 2.III.) In that brief sentence can be found the justification for Keynes's rejection of the real bills doctrine, the related Say's Law of Markets on which the real bills doctrine is based, the redefinition of money and interest, intrusive State control of the economy — and egregious misuse of the Federal Reserve System.

The reasoning is relatively straightforward. If "wealth was divided equitably," owners would use the income generated by their capital for consumption. Businesses would have to borrow money from commercial banks in order to finance capital formation — money that commercial banks have the power to create by discounting, and to back up with the "faith and credit of the United States" by rediscounting at the Federal Reserve. To Keynes, however, using capital income for consumption was an improper use of that income, as he made clear a decade and a half later in his General Theory with his reference to "functionless investors." (VI.24.ii.) Money creation by the commercial banks backed up by the central bank through the application of the real bills doctrine is, according to Keynes, impossible . . . even though history has proved time and again that commercial banks do, in point of fact, create money all the time, and legitimately so if the money is created in direct response to capital projects that generate their own repayment, and the assets financed are linked to the new money created by private property. (See Harold G. Moulton, The Formation of Capital, 1935.)

The problem was that Keynes accepted the tenets of the British Currency School without question. With respect to Dodge v. Ford Motor Company, the most important of these tenets (and the one disproved by the real bills doctrine and Say's Law of Markets) is that it is impossible to finance new capital formation without first cutting consumption, accumulating savings, then investing. The job of a central bank in Keynes's theory is not to finance new private sector capital — again, that (according to Keynes) is impossible — but to redistribute purchasing power through inflation and "forced savings" by monetizing government deficits, thereby generating full employment — if we define "full employment" as a wage system job for everyone, or nearly everyone.

Given the assumption that only existing accumulations of savings can be used to finance capital formation, ownership of the means of production must be concentrated in as few hands as possible. This ensures that the owners of capital cannot, despite their best efforts, spend all of the income their capital generates, and are forced to save and reinvest the excess, just as Henry Ford proposed. The greater the concentration, the greater the excess, and the greater the "immense accumulations of fixed capital" that presumably benefit humanity that can be built up. In this framework, paying dividends changes from an exercise of the natural right to be an owner and thereby enjoying the fruits of ownership, to being a counterproductive act that harms, even halts economic growth. (This belief was, again, completely disproved by Moulton in The Formation of Capital, but that had no effect on the fixity of the belief, or the religious devotion with which academic economists and government policymakers have adhered to it.)

Thus, thanks in large measure to the combined prestige of Henry Ford and John Maynard Keynes, the effective abolition of private property for the great mass of people became enshrined in law, economic theory, and fiscal and monetary policy — and thus into the United States Internal Revenue Code and, most especially, into the policies of the Federal Reserve System. The central bank of the United States now had both legal and theoretical justification in addition to political expedience as reasons to change its mission from providing adequate liquidity to the private sector for industrial, commercial, and agricultural projects, to funding government deficits and attempting to control the economy by imposing effective State control of money and credit.

An owner has the right to the profits generated by what he or she owns. Denying this right, as Henry Ford tried to do to the Dodge brothers, and for which Keynes provided the presumed theoretical basis, however unsound, abolishes private property to that degree. Common myths about how capital formation is financed provide the justification for this undermining of a natural right. There are two essential reasons for this.

• First, of course, capital isn't usually financed out of existing accumulations of savings — directly. The chief use of savings (which necessarily equal investment, as Keynes agreed, indeed, insisted on) is as collateral for debt financing. Henry Ford undermined the natural right to private property in two ways by accumulating cash to finance plant expansion: 1) he denied the Dodge brothers their fruits of ownership by attempting to withhold dividends, and 2) he violated principles of sound finance embodied in the real bills doctrine and Say's Law of Markets, thereby monopolizing access to the means of acquiring and possessing private property, necessarily throwing the economy out of equilibrium.

• Second, Henry Ford's chosen method of concentrating ownership — and thus power — in his own hands guaranteed that he would be accountable to no one for any of his actions. By concentrating ownership, Ford effectively negated others' right to be an owner, and actually went so far as to work to strip others not only of the rights of ownership, but of ownership itself.

While not generally recognized, Dodge v. Ford Motor Company and The Economic Consequences of the Peace helped set the stage for the Crash of 1929 and the current financial crisis. It did this by shifting the incentive for share ownership from anticipation of a future stream of dividends, to speculation in the value per share itself. "Investment" became redefined in the popular mind (and in that of many financial professionals) as buying and selling in anticipation of a rise or fall in the value per share, not in putting resources to work in a productive endeavor. The result was a near-total divorce of "investment" and share ownership from the revenue stream generated by profits of production.

Thus, between the two of them, Henry Ford and John Maynard Keynes managed to separate ownership from the rights of ownership. Ford did this directly, by taking away the rights of minority owners to a pro rata portion of control and income generated by what is owned. Keynes did this indirectly, by separating issuance of money from direct ownership of the assets that necessarily back the money. Ford and Keynes can be given credit for helping to destroy private property as a widespread institution in the modern world.

#30#

A Little More on William Cobbett, Part II

As we saw in yesterday's posting, many people are firmly convinced that the only two possible economic systems in the world are capitalism or some variety of socialism. Capitalism being discarded as heartless, greedy, and cruel, the only alternative is socialism — which is heartless, envious, and cruel. Nor does it have to be called socialism. It is only necessary that socialism's substantial nature be present. That, as Karl Marx clearly stated in The Communist Manifesto (1848), is the abolition of private property in the means of production.

Unfortunately, socialism — by whatever name — has more flaws than capitalism. Believing private property in the means of production to be the root cause of injustice, socialists either abolish private property outright, or redefine it in ways that result in its effective abolition. What they miss is that capitalism, properly defined, is not a system based on private property, per se, but on concentrated ownership of the means of production as a necessary, even beneficial thing. As John Maynard Keynes, the architect of the modern welfare State (that uneasy marriage of capitalism and socialism), declared dogmatically at the start of his career, "The immense accumulations of fixed capital which, to the great benefit of mankind, were built up during the half century before the war, could never have come about in a Society where wealth was divided equitably." (John Maynard Keynes, The Economic Consequences of the Peace, 1919, Chapter 2, Section III.)

The solution to capitalism, then, is not to concentrate ownership of the means of production even more so in the hands of an impersonal State, but to spread ownership out through just means that respect the dignity of all people, not only those recognized as fully human by those who seize power. This means that (attractive as the prospect might appear to outraged arbiters of the behavior and moral standing of their fellow man) it is wrong to confiscate the wealth of some for redistribution among others to enhance the latter's quality of life. This violates the human dignity of those whose property rights were violated. The end, contrary to the dictum of Machiavelli, does not justify the means.

Confiscation and redistribution to meet an emergency, such as plague or famine, or even individual dire necessity is a separate case that, in any event, is not a blueprint for the way society should be run, but an expedient to meet an emergency. It is an application of the "principle of double effect," whereby something that is not objectively evil, that is, evil in and of itself, may be done on a temporary basis as an expedient in order to achieve an end whereof the intended good outweighs the unintended evil.

In light of the necessity of keeping both ends and means consistent with universal principles, what the interfaith Center for Economic and Social Justice ("CESJ") calls the "Just Third Way" appears to offer an acceptable alternative to both capitalism and socialism. The Just Third Way is an arrangement of society, with emphasis on the economy, based on the dignity and sovereignty of every person. "Dignity" is not just a handy catch phrase, however. It means recognition and protection of the inalienable rights possessed by each and every human being, consistent with universal — "natural law" — principles of justice. "Inalienable rights are also referred to as "inherent" or "absolute," i.e., not subject to be taken away or their exercise inhibited or prevented except for just cause and due process by duly constituted authority.

These human rights, such as life, liberty, and property, are derived from a transcendent source of natural law and universal moral principles. The Just Third Way uses the Aristotelian/Thomist view of the natural law as based on human nature, as opposed to the view of, e.g., Grotius and Puffendorf, that the natural law is based on direct revelation from a deity. Within this system all social institutions and laws are structured to be subordinate to and supportive of the dignity, sovereignty, and full development of each person within a just social order. To this end the Just Third Way promotes — as a fundamental human right — access to the means of acquiring and possessing the full rights and powers of private property in income-generating capital, as well as in one's own labor.

William Cobbett agrees. As he explained in many of his writings, but never more forcefully than in A History of the Protestant Reformation in England and Ireland (1826),

Freedom is not an empty sound; it is not an abstract idea; it is not a thing that nobody can feel. It means, — and it means nothing else, — the full and quiet enjoyment of your own property. If you have not this, if this be not well secured to you, you may call yourself what you will, but you are a slave. . . . You may twist the word freedom as long as you please, but at last it comes to quiet enjoyment of your own property, or it comes to nothing. (§ 456)

William Cobbett may have been an unwitting adherent of the tenets of the British Currency School and believed the only way to acquire and possess private property in the means of production is to cut consumption and save. He agitated against inoculation against smallpox, thought potatoes unhealthy, and even committed the unforgivable crime in the eyes of today's liberals in thinking the United States the greatest country on earth where England's mistakes were corrected. He put the cap on his radicalism by maintaining that taking public welfare or a State pension made you a slave of the State, whether or not you felt yourself entitled to it.

Cobbett had one distinct advantage over today's economists and politicians, however. He knew that ownership of an adequate stake of the means of production — with ownership an absolute right of every human being, even while the exercise of that right is necessarily limited — is virtually the sole means most people have to secure and enjoy their other natural, absolute rights of life, liberty, and the acquisition and development of virtue to become more fully human — the "pursuit of happiness." He was truly the apostle not only of distributism, but of the Just Third Way.

#30#

The Political Animal, Part XXI

In the previous posting in this series we discovered that a society had developed in the United States of the 1830s that appeared to adhere more closely to the natural moral law based on the divine Intellect (Nature) than any previous arrangement in history. As Alexis de Tocqueville analyzed the situation, "By the side of every religion is to be found a political opinion, which is connected with it by affinity. If the human mind be left to follow its own bent, it will regulate the temporal and spiritual institutions of society in a uniform manner, and man will endeavor, if I may so speak, to harmonize earth with heaven." ("Causes Which Tend to Maintain Democracy: Religion Considered as a Political Institution Which Powerfully Contributes to the Maintenance of a Democratic Republic Among the Americans," Volume I, Ch. XVII)

Surprisingly, perhaps even shockingly to today's liberal who detects a lurking and insidious evil in public displays or expressions of religion of any sect, but who singles out the Catholic Church as especially obnoxious in this regard, de Tocqueville professed to see in Catholicism a particular affinity for and support of the best in American democracy. According to de Tocqueville, the Catholic population of the United States, particularly those of Irish birth or descent, while a minority, provided the country with a solid core of citizens who were, at one and the same time, both independent minded, and submissive to good laws that promoted equality and social order. De Tocqueville claimed that in America, even where strict observance of Catholic practices according to the letter of the law faded or was non-existent (as among Protestants and adherents of other faiths), nowhere was there stronger adherence to the spirit of Catholicism, even among non-Catholics, particularly when conforming political institutions to the precepts of the natural moral law. (Ibid.)

Nor was de Tocqueville alone in his opinion that Americans had somehow reconciled humanity's social and individual natures. Immediately following the Civil War, Orestes Brownson published his own study of the United States, The American Republic (1865). Brownson, with Emerson and Thoreau considered one of the "top three" Transcendentalists in the United States until he converted to Catholicism in the 1840s and was swept under the rug of history, was even more explicit than de Tocqueville in his belief that America represented something genuinely new.

Once the country corrected (more or less) its "original sin" of chattel slavery with the bloodiest war in American history, the stage was set for America to fulfill its true purpose. Brownson believed that the United States was chosen by God to continue reconciling humanity's individual and social natures and provide, as far as humanly possible, the ideal environment within which man could become more fully himself. As Brownson put it in the introduction to the book that he considered his finest achievement,

The United States, or the American Republic, has a mission, and is chosen of God for the realization of a great idea. It has been chosen not only to continue the work assigned to Greece and Rome, but to accomplish a greater work than was assigned to either. In art, it will prove false to its mission if it do not rival Greece; and in science and philosophy, if it do not surpass it. In the State, in law, in jurisprudence, it must continue and surpass Rome. Its idea is liberty, indeed, but liberty with law, and law with liberty. Yet its mission is not so much the realization of liberty as the realization of the true idea of the State, which secures at once the authority of the public and the freedom of the individual — the sovereignty of the people without social despotism, and individual freedom without anarchy. In other words, its mission is to bring out in its life the dialectic union of authority and liberty, of the natural rights of man and those of society. The Greek and Roman republics asserted the State to the detriment of individual freedom; modern republics either do the same, or assert individual freedom to the detriment of the State. The American republic has been instituted by Providence to realize the freedom of each with advantage to the other. (Orestes Brownson, "Introduction," The American Republic, 1865)

Despite some vagueness in terminology regarding social rights, Democracy in America and The American Republic share common assumptions. Chief among these is that the human person and thus the State, a human artifact, are based on and must conform to God's Nature, even when not following someone's interpretation of what may (or may not) be God's Will. Where de Tocqueville focused on the sociological aspects of a government of the people, by the people, and for the people, however, Brownson explored political philosophy and science.

De Tocqueville and Brownson are not in competition. Both Democracy in America and The American Republic should be read as necessary complements to each other. De Tocqueville, for example, appears to assume as a given that when he refers to "Catholic political philosophy" his predominantly French and presumably Catholic readers know what he is talking about. On the other hand, Brownson, addressing an audience composed largely of non-Catholics, went to great lengths to explain of what that philosophy consists and why the American republic embodies Catholic political philosophy to a greater degree than any previous State in history.

Similarly, Brownson's audience in 1865 consisted primarily of small landowners and other proprietors who were fully aware of the importance of private property as the chief support for other natural rights, such as life, liberty, and pursuit of happiness (i.e., the acquisition and development of virtue). Other than to explain some technicalities about property and its importance as a natural right and to condemn both socialism and capitalism, Brownson spent very little space on ownership and private property. Nevertheless, he clearly considered widespread direct ownership of the means of production critical to the survival of a healthy State and a moral social order — hence his devastating critique of what he considered the deadly poison of socialism:

It wears a pious aspect, it has divine words on its lips, and almost unction in its speech. It is not easy for the unlearned to detect its fallacy, and the great body of the people are prepared to receive it as Christian truth. We cannot deny it without seeming to them to be warring against the true interests of society, and also against the Gospel of our Lord. Never was heresy more subtle, more adroit, better fitted for success. How skillfully it flatters the people! It is said, the saints shall judge the world. By the change of a word, the people are transformed into saints, and invested with the saintly character and office. How adroitly, too, it appeals to the people's envy and hatred of their superiors, and to their love of the world, without shocking their orthodoxy or wounding their piety! Surely Satan has here, in Socialism, done his best, almost outdone himself, and would, if it were possible, deceive the very elect, so that no flesh should be saved. (Essays and Reviews Chiefly on Theology, Politics, and Socialism, 1852.)

Brownson, of course, didn't have to deal with today's modernists and positivists and their word games, or the circumlocutions employed by both capitalists and socialists to try and whitewash their dogmatic beliefs under different names, such as "democratic capitalism (or socialism)," "solidarism," or even "Christian socialism." No, Brownson knew exactly what socialism is, and defined it the same way as Karl Marx in The Communist Manifesto: the abolition of private property in the means of production. In the America of Brownson's day, no person considered sane questioned the importance of private property in the means of production, whether or not he or she agreed that direct ownership of capital should be widespread.

De Tocqueville, on the other hand, wrote primarily for a French and English audience, both countries in which the tradition of small ownership had been eroded for centuries, as William Cobbett frequently pointed out in his polemical works. Consequently, de Tocqueville stressed far more than Brownson the importance of widespread direct ownership of the means of production as the chief support for other natural rights.

The problem, of course, is obvious, at least in hindsight. The Industrial Revolution had received a great impetus in the United States due to the Civil War. Many authorities, then as now, credited the Union victory to the industrial and commercial might of the North. In mid-century, however, relatively few people were directly engaged in industrial and commercial enterprises, even as wage earners. Contrary to the assertions of David Christy in Cotton is King (1855), even in the South before the war, relatively few people — including slaves — were employed on plantations engaged in the production of goods, services, and commodities for the international market. Most slaveholders owned less than a dozen slaves, usually only one or two, and were engaged in subsistence agriculture or production of goods and services for the local market. The vast majority of the population, North and South, were engaged in subsistence agriculture, artisan type production of goods, or kept small shops.

All of this changed with Abraham Lincoln's 1862 Homestead Act and the opening of the "Great American Desert" to settlement — and as a vast new market for the goods being produced in the increasingly industrialized East. The Homestead Act changed the essential character of American agriculture from subsistence farming supplemented with small "cash crops," to production primarily for market, with basic necessities purchased instead of being homegrown. (Laura Ingalls Wilder brilliantly chronicled this change in her "Little House" books.) [This assumption is so engrained in American tax and agricultural policy that in 1948, the decision in the landmark case Wickard v. Filburn (317 U.S. 111 (1942)), that greatly increased the economic power of the federal government, held that all agricultural production, even that which was consumed on the farm where it was produced, was subject to the interstate commerce clause, whether or not it was produced for market.] Similarly, as the settlement of the West opened up a new market, the pace of industrialization increased. Settlement and industrialization not only complemented each other, neither would have been possible — or, at least, as successful — without the other.

Unfortunately, while agricultural capital — land — was broadly owned, with the ownership base rapidly expanding due to the Homestead Act, ownership of the new and growing commercial and industrial enterprises was becoming increasingly concentrated. By 1905, when Judge Peter Stenger Grosscup, one of Theodore Roosevelt's "Trust Busters," wrote a series of articles addressing the situation, small ownership of commerce and industry had, for all practical purposes, disappeared as a feature of American life.

Concentration of ownership of what was becoming responsible for the bulk of production of marketable goods, services, and commodities built a serious conflict into the system. As Louis Kelso and Mortimer Adler pointed out three-quarters of a century later (The Capitalist Manifesto, 1958, and The New Capitalists, 1961), concentrated ownership is not due to some law of nature, as both capitalists and socialists assume even to this day. On the contrary, concentrated ownership of the means of production is directly attributable to a profound misunderstanding of money and credit, and thus a misapplication of incorrect assumptions to the task of financing capital formation, whether that capital is in the form of industrial, commercial, or agricultural assets.

This misunderstanding about money and credit has a profound influence on how people view the political process. Nowhere is this more evident than in the work of two Englishmen, Walter Bagehot and Albert Venn Dicey. Briefly (for this is not the place to get into an in-depth analysis of the differences between the two), Bagehot, who expressed great disdain for the United States, was a firm adherent of State-controlled monopoly capitalism (described in his book, Lombard Street, 1873) — with the State itself controlled by "the money interests." Clearly taking the "law is will" position (lex voluntas), Bagehot advocated a form of "democracy" in which, consistent with the principles laid out by Thomas Hobbes in Leviathan, the commercial and financial elite rather than the hereditary monarchy or aristocracy controlled the country, as was the case in India before the Great Mutiny (The English Constitution, 1867). Not surprisingly, Bagehot was an adherent of the British Currency School, defining "money" essentially as a State-authorized purchase order.

Dicey, Bagehot's most effective philosophical opponent, was a firm believer in the rule of law, and popularized the concept on both sides of the Atlantic. A great admirer of the United States (unlike Bagehot, who never visited America, Dicey paid an extended visit to the U.S. in the 1870s), Dicey unfortunately avoided the economic issue, focusing on purely political matters. This may have been as a result of the inevitable conflict between a democratic political system, and an absolutist economic system.

For whatever reason, Dicey, a firm adherent of the law is reason position (lex ratio), did not address the problems inherent in applying the elitist and undemocratic principles of the Currency School to a presumably democratic political system. Dicey's classic, An Introduction to the Study of the Law of the Constitution (1886), simply avoids the whole issue of economics, although he was appointed one of the first professors at the new London School of Economics in 1896. Dicey's Conflict of Laws, published that same year, concentrates largely on what is today known as "business law," and does not discuss the conflict between the two schools of monetary thought. On the other hand, Lectures on the Relation Between Law and Public Opinion in England During the Nineteenth Century (1905) is a brilliant analysis of the principle of subsidiarity, and its relation to the sovereignty of the individual manifested through membership in groups.

Incorrect assumptions about money, credit, and finance were built into the American system following the Civil War. Part of this was due to Treasury Secretary Salmon Chase's controversial decision to finance the Union war effort primarily through borrowing instead of taxation. There was, however, also the problem of the chaotic banking system, a situation made infinitely worse by the President Andrew Jackson's pyrrhic victory in his war against the Second Bank of the United States in the previous generation.

The National Bank Act of 1864, modeled on the British Bank Charter Act of 1844, did bring a measure of order to the financial system. Unfortunately the National Bank Act, in common with Sir Robert Peel's Bank Charter Act, embodied two false assumptions about money, credit, and finance that were to have serious repercussions in the decades to come, culminating in the "Panic of 1907."

These were, one, that "money," contrary to the natural moral law based on the Intellect, is and can only be a purchase order issued by the State or a State-authorized individual or entity. Two, that capital formation can only be financed out of existing accumulations of savings. With this in mind, the subtitle of Kelso and Adler's above-referenced second book, The New Capitalists, is revealing: "A Proposal to Free Economic Growth from the Slavery of Savings."

These two assumptions, widely accepted even today, flatly contradict the true nature of money as anything that can be used in settlement of a debt, and the science of finance as based on a regulated system of secured promises, with or without existing accumulations of savings. These elitist assumptions about money and credit — the life's blood of the community — came into direct conflict with the democratic American political system, with results that became ever more destructive of political and social stability as the century wore on.

Unfortunately, as the damage increased, people began to forget or ignore the basic principles and "rules" of democracy in America as discerned by de Tocqueville, and the true origin and transmission of the sovereign power as described by Brownson. In view of the apparent helplessness of the individual seemingly trapped in an impersonal system, people began to look to the State as the agency that alone could ameliorate the increasing disorder in society. We will begin to look at some of the responses to this disorder in the next posting in this series.

#30#

A Pro-Life Economic Agenda, Part V

A Pro-Life economic agenda sounds like a good idea, but it won't do any good if it doesn't work. Some people have asserted that the "Living (or Just) Wage" as described by Rev. John A. Ryan in his 1906 book, A Living Wage, is the only possible economic agenda for the Pro-Life movement. The serious flaws in the wage system, however, examined in detail by such diverse authorities as Karl Marx, Pope Leo XIII, G. K. Chesterton and Hilaire Belloc (the "Chesterbelloc"), and Louis Kelso and Mortimer Adler, as well as Msgr. Ryan himself pretty much take any reliance on wages as the sole source of a viable living income out of the running.

We can therefore dismiss the two main systems that rely on the wage system, capitalism and socialism. The only real difference between the two is the identity of the small elite that owns or controls ownership of the means of production, anyway. What we propose, then, is something analogous to Chesterton and Belloc's "distributism," or an economic arrangement of society characterized by widespread direct ownership of the means of production.

Classic distributism adds that there is a preference (not a mandate) for small, family-owned farms and artisan shops. Further, Chesterton and Belloc assumed as a given that existing accumulations of savings are necessary to finance capital formation. The goal, however, is more important than the specific means used to achieve the goal — particularly if the means are contrary to sound principles of economics and finance, or somehow violate fundamental principles of the natural moral law.

As we saw in the previous posting in this series, Capital Homesteading gets away from the presumed reliance on existing accumulations of savings to finance capital formation by going back to sound banking principles. A commercial bank that has the power to act as a "bank of issue" (that is, can issue banknotes or create demand deposits — checking accounts), can take a real bill — a lien on something of value — as security from a borrower. This is backed up with a capital credit insurance policy for additional security, or "collateral." The bank can then print banknotes or create a demand deposit in the amount loaned on the bill, and hand the banknotes or checkbook over to the borrower.

The borrower takes the "money" and invests it in a project that is reasonably expected to generate enough profit to repay the loan, buy back the real bill, and provide sufficient income for the borrower on which to live. When the loan is repaid, the bank cancels the banknotes or the demand deposit, and returns the bill to the borrower, who in turn cancels the bill.

Because the money is created in the same or lesser amount of the present value of the investment, there can be no inflation unless the investment fails. In that case, of course, the money supply is reduced by the amount of the capital credit insurance proceeds paid to the lender. The capital credit insurance company pays off on the policy, and the bank takes the money and cancels the money, the same way the bank would have had the loan been repaid by the borrower in the usual way. This offsets the inflationary impact of the prior money creation for the failed investment.

Thus, by getting the right to go to a commercial bank and borrow up to, say, $7,000, and participate with the bank in creating money in this fashion, a "Capital Homesteader" could, with the guidance of a competent financial advisor, purchase part ownership in: 1) companies for which a member of the family works; 2) a company where the Homesteader has a monthly billing account; or 3) "qualified" companies that are well-managed and highly profitable. Companies could also establish Employee Stock Ownership Plans (ESOPs) for their workers, and Consumer Stock Ownership Plans (CSOPs) for their regular customers to borrow funds repayable with future pre-tax profits, for the issuance of new shares, or for the purchase of existing shares.

Communities that adopt for-profit Citizens Land Cooperatives (CLCs) could attract interest-free credit to buy land for development or build new infrastructure. This would enable every citizen to participate as a shareholder in community land planning and governance decisions. Moreover, each citizen would share in the profits from rents and fees for the use of land and infrastructure. Through a Capital Homestead Act, access to capital credit — which today helps make the rich richer — would be enshrined in law as a fundamental right of citizenship, like the right to vote.

Using its powers under § 13 of the Federal Reserve Act of 1913, the Federal Reserve System would supply local commercial banks with the money needed by businesses to grow. The central bank would discount the real bills presented to commercial banks, instead of allowing banks to create money on their own. This would stabilize the currency and provide immediate 100% "hard asset" reserves for all the money in the commercial banking system.

An important feature of Capital Homesteading is that the new money and credit for private sector growth would flow through Capital Homestead Accounts and other credit democratization vehicles. This would ensure that as many people as possible had the means to acquire and possess private property in the means of production. Capital Homesteading would thereby enable a country to comply with the recommendation expressed by Pope Leo XIII in what is generally considered the first "social encyclical," Rerum Novarum (1891),

We have seen that this great labor question cannot be solved save by assuming as a principle that private ownership must be held sacred and inviolable. The law, therefore, should favor ownership, and its policy should be to induce as many as possible of the people to become owners. (§ 46)

Through a well-regulated central banking system and other safeguards (including capital credit insurance to cover the risk of bad loans), all citizens could purchase with interest-free capital credit, newly issued shares representing newly added machines and structures. These purchases would be paid off with dividends that the paying companies could deduct from their taxable income. Nothing would come out of anyone's existing accumulations of savings or reduce the income anyone uses for consumption purposes.

Once the acquisition loan was fully repaid, the Capital Homesteader would be the full, legal owner of the shares. Thereafter, the Homesteader would receive an adequate and regular income sufficient to meet common domestic needs from the earnings of the capital he or she accumulated over the years, and be able to pass it on to any children.

That is how Capital Homesteading is designed to work — although we have only hinted at the technical details of the proposal. It only remains to organize in solidarity with like-minded others, and get to work. The first step would be to visit the CESJ website and find out more about Capital Homesteading.

#30#