Rally for Monetary Justice

In the spirit of full dignity, empowerment and liberty for every person, and a life-enhancing future for every child, woman and man on our precious Earth, the Center for Economic and Social Justice and Coalition for Capital Homesteading invite you to join us April 22-23, 2016 for our annual social justice event, the Rally for Monetary Justice.

Focus on the Fed

This is the time of year many Christians celebrate (if that’s the right word) “Lent.”  Lent is a period of forty days (not counting Sundays) preceding Easter, whenever the powers-that-be decide that’s going to be, during which you, well, prepare for Easter.  Generally that means “giving up [fill in the blank] for Lent,” thereby achieving a feeling of immense self-satisfaction and virtue for having “given up” something you’d probably be better off without in the first place.

A Proper Response

The other day someone sent around an e-mail suggesting that violence could solve many of today’s massive social and economic problems.  From a certain perspective, that is correct.  The idea that “violence never solved anything” is, frankly, just plain wrong.  Violence solves a lot of problems.  It just usually leaves you with much bigger problems than you started with.

Own the Fed — the Program, Part XV: Own the Fed

We have seen in previous postings in this series that by means of some relatively straightforward reforms, the Federal Reserve System can be returned to its original purpose of providing adequate liquidity for the private sector without inflation or deflation. We have also seen that some additional reforms, such as the 100% reserve requirement, the two-tiered interest rate and extending the term of qualified paper would broaden application of the spirit and the original intent, if not necessarily the strict letter of the Federal Reserve Act of 1913.

Without a doubt, however, the most important reform that could be implemented is the proposal to use the money creation powers of the commercial banking system backed up by the Federal Reserve to expand the base of capital ownership in the United States. This would be done by requiring that all credit extended for new capital formation by commercial banks and rediscounted at the regional Federal Reserve banks creates money only in ways that creates new owners. To qualify for rediscounting, all paper presented at a Federal Reserve bank must include a feature that broadens the base of direct capital ownership in the United States.

Widespread direct ownership of the means of production, individually or in free association with others, is essential to the establishment and maintenance of a just economy, and thus a just and stable political order. To explain why this is so, it is appropriate at this point to reiterate the basic philosophy of the Just Third Way and thus Capital Homesteading, especially as it relates to the natural right to own the means of production as the ordinary and normal way of making a living.

The Just Third Way is based on the dignity of the human person, which — obviously — begins with the human person and puts him or her at the center of things. As an application of the principles of personalism, the Just Third Way recognizes that dignity — and thus personal sovereignty, natural rights, the acquisition and development of virtue, and so on — is inherent in every human being. None of these things are received as a grant from another individual, group, institution, or even an all-powerful State. They are part of human nature and are therefore inalienable from the human person.

Further, in recognition of our political nature we are obligated as individual members of the human race to act in accordance with our political nature. It is therefore our responsibility to organize with others to perfect the social order to support the dignity and empowerment of every human being. We necessarily recognize the fact that every human being at whatever stage of physical, mental, spiritual, cultural, political, economic, or anything else, development is as fully human, and thus as fully a person, as everyone else.

The Just Third Way integrates the principles of "binary economics." In binary economics, which can thus be described as "economic personalism," there are two interdependent factors of production: 1) "labor," or all human inputs, and 2) "capital," or all non-human inputs. The two legitimate ways to engage in the production of marketable goods and services and to be entitled thereby to the income generated are 1) to contribute one's labor, and 2) contribute one's capital. A free and open market that operates within a simple and clear, if strong juridical order can determine the relative value of each of these inputs, and thus the basis for distribution. A market that is truly free therefore requires equal access to the means of acquiring and possessing private property in the means of production.

The Just Third Way embodies three essential principles of economic justice. These are 1) participation, 2) distribution, and 3) harmony. The principle of participation — participative justice — is that everyone necessarily has the right to participate fully in all institutions of the common good, including a right of access to the means to participate. This principle requires that every person have access to the means and opportunity to contribute economic value through both labor and capital inputs. In economic justice, distribution follows participation. What each person is entitled to receive is determined by his or her relative contribution/participation. As advancing technology begins to contribute a proportionately greater share than human labor to the production of marketable goods and services, participative justice demands the elimination of barriers to capital ownership. Participative justice also requires the universalization of access to such social goods as capital credit through a well-organized banking and legal system.

The principle of distribution — distributive justice — is the outtake principle that holds that the contribution of labor to the economic process should be compensated at the market-determined rate (or "just wage") for each particular type of human contribution to the production of marketable wealth. This principle dictates that the contribution of capital should be compensated by the "just profit" generated by the project or enterprise. Profit is determined by the market-based rental value of contributed capital assets, or by the gross revenues resulting from market-determined "just prices" less the market-based cost of the factors of production, including labor.

Harmony — social justice — is the feedback principle that balances and restores participation and distribution within the economic system. Kelso and Adler called this the "principle of limitation" as it calls for the restructuring of the economic system to restore participative and distributive justice.

Finally, the Just Third Way also incorporates the four pillars of an economically just society:

• A limited economic role for the State,

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

• Restoration of the full rights of private property, particularly in corporate equity, and (the "fatal omission" in all economic systems today),

• Widespread direct ownership of the means of production, individually, or in free association with others.

This last is generally considered the distinguishing characteristic of the Just Third Way, although it must always be understood within the context of, and the exercise limited imposed by the other three pillars. For example, while everyone has the natural right to own, we may never use what we own to harm ourselves, other individuals, groups, or the common good as a whole. Understanding that "property in everyday life, is the right of control," (Louis Kelso, "Karl Marx: The Almost Capitalist," American Bar Association Journal, March 1957) Kelso and Adler best illustrate the importance of private property in the means of production by their analysis in The Capitalist Manifesto (op. cit.).

In "Elementary Economics" (ibid., 33-51), Kelso and Adler explain that "property" means primarily the right to control what we own, use it, derive benefits, or dispose of it in any lawful manner. (Ibid., 43.) There are two important points with regard to property. The first is that "property" can be subdivided into "innate" and "acquired" property. Innate property is that which the human person possesses as part of his or her nature, that is, by natural right. Economically speaking, innate property is limited to labor, whether physical or mental. (Ibid.) Acquired property is everything external to the human person to which he or she has established his or her right to control. (Ibid., 44.) The second point is that ownership of productive assets can be put into three broad categories: 1) property in natural resources, 2) property in capital, and 3) property in labor. (Ibid., 44-45.)

Private property in the means of production is thus the normal and legitimate way to connect the human person to the means of production. Private property thereby conveys to the owner all of the benefits of ownership, including enjoyment of the fruits (income), control, and disposal, albeit within the constraints of the common good. Anything other than private property in the means of production as the source of income is at best an expedient. Given certain conditions of society (see John A. Ryan, A Living Wage, 1906), it may be necessary at times to pay wages at a level necessary to meet common domestic needs adequately without regard to the economic value of the labor input supplied. Such measures, however, should not be tolerated any longer than it takes for people to organize and restore harmony by restructuring the relevant institutions of the common good, thereby making it possible for people to become owners of a capital stake sufficient to generate an adequate and secure income.

Private property in the means of production is implicit in Say's Law of Markets and the real bills doctrine. These are cornerstones of binary economics and the basis for the original conception of the Federal Reserve. In relevant part, Say's Law states that we do not purchase the marketable goods and services produced by others with "money," but with the goods and services that we produce. This thing we call "money" is merely the medium through which we exchange our production of goods and services, for the goods and services produced by others. (Say, Letters to Malthus, loc. cit.) For this medium of exchange to be legitimate and honest, the present value of existing or future inventories of marketable goods and services must stand behind or "back" all money.

The real bills doctrine is, essentially, a restatement of Say's Law, or vice versa, depending on how you approach the matter. That is, "money" can be created as needed or canceled without inflation or deflation, as long as all money created or cancelled corresponds to the increase or decrease in the present value of existing and future marketable goods and services, and all money created or cancelled is linked directly to the present value of marketable goods and services through the institution of private property.

Thus, in binary economics (and therefore the Just Third Way) all factors of production — everything that can be owned as private property — are put into two sweeping categories, the human, and the non-human. All human factors of production, normally separated into labor and entrepreneurship — and possibly others — are grouped under "labor." All non-human factors of production, whether natural resources, human artifacts such as machinery, tools, management systems, and so on, are grouped under "capital." This is the most useful and practical way of looking at the factors of production for the purposes of economic analysis.

When structuring how things are to be owned, however, we find it convenient, possibly even essential, to separate not only the human factors of production from the non-human factors, but to subdivide the non-human factors into artifacts and non-artifacts. (This terminology appears to be new, as this writer has not seen anyone use it before in the context of binary economics, but it seems to be the most descriptive, and thus most accurate way of dividing the two types of non-human factors of production.) "Artifacts" consist of everything that is the fruit of human ingenuity. "Non-artifacts" consist of everything that humanity did not make. Non-artifacts are things like land, natural resources, air, water, and so on.

Non-artifacts are often subdivided even further into "economic goods" and "non-economic goods." In binary economics, however, the concept of "non-economic good" is not truly descriptive. The term denotes a factor of production that is presumably "cost free." A factor of production, however, is never "cost free." The cost may be indirect, as in the sums expended by government or private groups to clean up polluted air and water. The cost may even be intangible, as in the lessened quality of life enjoyed by people living in an environmentally degraded area. In no case, however, is anything ever "cost free" as a factor of production. It may be difficult and even seem virtually impossible to assign the cost to those who enjoyed the benefits, but the cost does not thereby disappear.

The important point here, however, is to reaffirm the dictum of Roman law that "all things have their proper owner." This does not mean that owners may use what they own in any way that harms themselves, other individuals, groups, or the common good as a whole. Private property is absolute in that every human being has the right to be an owner, but the right to be an owner necessarily implies limitations on the exercise of the rights of property. Different types of things may be owned, but, depending on the type of thing, social conditions, limitations of physical existence, and so on, different kinds of things may be owned in different ways, even within the same society. For example, the right to keep and bear arms in the United States is generally interpreted as not including weapons of mass destruction, atomic bombs, or automatic rifles and machine guns.

Thus, non-human factors of production that fall into the non-artifact category, such as land and natural resources, should ideally be directly owned by everyone, rather than monopolized by a few private individuals or the State. This can be through something like a "natural resource bank," or "Citizens Land Cooperative" ("CLC") in which every resident of a region (even, conceptually, the entire world), directly owns a pro rata share of all non-human non-artifacts through the medium of a single, no-cost, non-transferable lifetime share in the resource bank or CLC.

There is another type of non-human factor of production that, while created by human beings, is not susceptible to ownership, at least, not in a well-ordered society. This category includes such things as government services (police services, administering justice, defense, etc.), as well as voting and other civic rights and duties. While people providing such services must frequently be paid, no one properly speaks of purchasing or controlling as owners police services, justice, or defense. These are uniquely social goods.

Nor can anyone speak of owning other human artifacts in the category of social goods such as systems of weights and measures. No one can have a monopoly on the number of inches we are permitted to use, or the quantity of pounds and tons allowed to circulate in society. These are means of measuring what exists; they are symbols without an independent existence of their own. In a very real sense, systems of measurement are derivatives of what they measure, having no true value of their own, relying absolutely on the value of whatever stands behind the symbol. Finally, in the category of uniquely social goods we have the money creation powers of a commercial banking system, especially when supported and backed up by a properly run central bank.

This does not mean that banks and money cannot be owned as private property. While banks, especially central banks, can be owned by the State, there is nothing to prevent financial institutions being controlled by private citizens — just as the State itself is presumably accountable to its citizens. State ownership of anything that can be privately owned is, in fact, an extremely dubious arrangement. It is a mode of organization fraught with peril for any society with pretensions of respect for human dignity and personal sovereignty.

What cannot be owned is the ability to create money, for that is inherent in the human person as a natural derivative of the rights of private property and the human capacity to make and keep promises. As we have seen with Say's Law and the real bills doctrine, however, what can — and must — be owned, and privately owned, is what money represents, as well as the institution(s) that create(s) the money. As George Mason pointed out in the first paragraph of the Virginia Declaration of Rights, the natural ("inherent") right to be an owner necessarily includes the right to use all legitimate means of becoming an owner.

The problem today, however, is that what is known as the financial services industry is controlled by a relatively small number of very large companies. The problem is complicated by the fact that many, if not all of these companies combine functions that are incompatible with sound principles of internal control. This comes into direct conflict with the principle of subsidiarity, and thus impinges on personal sovereignty and respect for individual human dignity.

Further, the fact of concentration of control over money and credit itself militates against democratic access to the means of acquiring and possessing an ownership stake in the means of production. It becomes obvious that control over money and credit cannot be monopolized or even concentrated to any degree if a society is to have any hope of maintaining any semblance of democracy — and control, remember, is synonymous with property. The best means of securing control over anything is through the institution of private property.

Breaking up the concentrations of control over money and credit in today's financial services industry is thus an absolute necessity if we are to establish and maintain an economically just society. The first step in that process is, as we have seen, to reinstitute legislation similar to the Banking Act of 1933 — Glass-Steagall. No financial institution can be permitted to carry out incompatible functions, of which the most obvious are commercial banking, investment banking, and insurance. All three must be independent in fact as well as in appearance.

Some might be tempted to protest that requiring the financial services industry to separate functions in accordance with the principles of sound internal control violates the rights of private property. Not so. Recall that while the right to be an owner — the right to property — is inherent in every single human being, the exercise of the rights of property is necessarily limited. Most simply put, no one may use what he or she owns to harm anyone. It becomes common sense, then, to structure our institutions in such a way that it is no longer advantageous to harm others — even if inadvertently by removing checks and balances and structuring our institutions so that errors and even honest mistakes are not caught in time.

The concentrated ownership of existing financial services companies is another issue in and of itself. While it would be ideal if all commercial and investment banks as well as insurance companies were broadly owned, it is not, strictly speaking, necessary that existing accumulations be broken up any further than required by principles of sound internal control. Taking away what some people already own for the benefit of others, even if presumably fair compensation is offered, when not demanded by the common good is more than a limitation on the exercise of private property. It is a violation of private property, and unjust by its nature. Limiting the exercise of private property to the extent demanded by the common good is one thing. Violating private property to satisfy a preference of even a great many people is quite another.

In any event, within a society that not only encourages widespread ownership of the means of production but provides access to the means to acquire and possess private property, the present concentrated accumulations of ownership — and thus control — in the financial services industry will be broken up naturally within a generation, if that long:

• By freeing the financing of capital formation from the slavery of past savings, entry into the financial services industry will become much easier, increasing competition.

• Replacing fractional reserves provided out of capitalization and deposits with 100% reserves supplied by rediscounting qualified paper at the Federal Reserve will mean that smaller financial institutions will be more able to serve their customers in a more cost-efficient manner than the bloated conglomerates that characterize today's financial services industry.

• Increasing specialization will result in a significant growth in efficiency as well as accountability.

• Finally, there is a natural limitation on all wealth — the lifetime of the owner. No one has yet figured out a way to take it with him.

For these and possibly other reasons, aside from imposing a necessary measure of common sense internal control, there is probably no reason to worry about the concentration of ownership in the financial services industry, any more than in any other sector of the economy. People with existing accumulations of wealth can be guaranteed that they will be secure in the enjoyment of their property — with one exception: government bureaucrats and politicians who, without having legal title (cf. the private sector "economic dictatorship" in Quadragesimo Anno, op. cit., §§ 88, 105-110), control the Federal Reserve System, the central bank of the United States.

As we have repeated endlessly, the best way to secure control over something is by means of the institution of private property, if for no other reason than property means control. The obvious answer to the problem of the virtual takeover of the central bank by private interests or the State is to vest direct ownership of the central bank in the citizens.

Direct citizen ownership of the Federal Reserve, rather than "ownership" by "the People," is the best way to establish accountability and to ensure that the money power is vested in the hands of private citizens, those who own the capital assets and inventories of marketable goods and services that necessarily back a sound and stable money supply. To put it simply, due to its special nature and its function in monetizing existing and future production to provide the medium of exchange for the economy, the Federal Reserve (any central bank, in fact) should be regarded as another, fourth branch of government — but with a difference.

The Federal Reserve is unique among government agencies in that it has the capacity (and was designed and intended) to provide a service that can be construed as marketable — the monetization of the present value of existing and future marketable goods and services. Commercial banks, of course, take fees and make a profit for providing the same service. As a branch of government, of course, the Federal Reserve may take a fee sufficient to cover the costs of creating money and administering the system, but making a profit is contrary to the whole orientation of government.

It would, of course, be entirely feasible in economic terms to implement a Capital Homesteading program without direct citizen ownership of the Federal Reserve. The issue, however, is not financial feasibility, but political feasibility. When the commercial banking system, a national bank, or a central bank is under any form of effective control by government, the temptation to divert the straightforward mission of the system or institution to advance political ends is overwhelming. This has been the case from the time of John Law and the Mississippi Bubble, down to the purchases of toxic mortgage-backed securities by the Federal Reserve, as well as the millennia of debasement of the coinage as a tool of monetary policy, whether we look to Diocletian, or Henry VIII Tudor. Government simply cannot be trusted with control over the creation of money and credit, although the State necessarily regulates the value of the currency and sets required standards. Every citizen should therefore be issued a single, no-cost, fully voting, fully participating, non-transferable share in the regional Federal Reserve as a fundamental right of citizenship.

There are, as we might expect, a great many details that need to be worked out for a reform of the Federal Reserve. The purpose of this survey is not to draft legislation or even give guidelines for legislation, but to make the case for reform of America's central bank and recommend specific correctives to return control of the money power to the people, establish and maintain a stable currency, finance widespread direct ownership of the means of production, and increase the asset-backed money supply from the current 60% to effectively 100%.

The actual structuring and implementation of the reforms is a matter for further study. Our goal has been to point out the need for reform, present the basic principles consistent with the Just Third Way and binary economics, and offer specific, if general correctives. In this way we can best advance the cause of human dignity within the framework provided by the Just Third Way and applied in Capital Homesteading for every citizen.

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Own the Fed — the Program, Part XIV: Extend the Term of Qualified Paper

According to the provisions of the original Federal Reserve Act of 1913, the central bank was only to be concerned with temporary increases or decreases in the money supply in order to avoid the twin evils of inflation and deflation. Consistent with classic commercial banking theory, the focus was on rediscounting short-term commercial paper with a term of ninety days or less in order to meet temporary liquidity needs of the private sector.

By far the largest part of the money supply in 1913 consisted of what we have termed "private sector money," that is, bills drawn on the present value of existing and future marketable goods and services. The vast bulk of such private sector money circulated, as today, between businesses and even countries without being discounted at a commercial bank in exchange for currency or (more usually) demand deposits. Even today, when the Federal Reserve has vastly increased the amount of debt-backed money in circulation, this asset-backed private sector money accounts for up to 60% of the money supply, and is the only thing keeping the economy going.

Under the terms of the original Federal Reserve Act, private sector money was to be supplemented (in order of importance) by 1) commercial bank discounts of short-term paper as well as long-term notes for fixed capital financing, 2) savings deposited in commercial banks, 3) government-issued coin and notes (e.g., gold and silver certificates and United States Notes), 4) Federal Reserve rediscounts of qualified primary issuances of commercial paper originally discounted by member banks, and — in distant last — 5) Federal Reserve open market purchases of secondary issuances of qualified securities issued by non-members banks and other private sector institutions. The Federal Reserve was thereby construed as the lender of last resort to the private sector in order to provide adequate liquidity to prevent both inflation and deflation, and to ensure that control over money and credit would be decentralized.

An important aspect of the deconcentration of control over money and credit was the prohibition against the central bank monetizing government debt. The dangers of allowing the government to finance itself without recourse to taxation was, of course, the most important reason for prohibiting the Federal Reserve from dealing in primary issuances of government securities. The only provision for dealing in government-issued debt paper was in §§ 14 and 19 dealing with reserve requirements for commercial banks. The Act restricted transactions involving government securities to secondary issuances bought and sold on the open market to ensure that the Federal Reserve had the direct power to affect reserve requirements.

As the report of the Pujo Committee (U.S. Congressional House Committee on Banking and Currency, Report of the Committee Appointed Pursuant to House Resolutions 429 and 504 to Investigate the Concentration of Control of Money and Credit, February 28, 1913. Washington, DC: U.S. Government Printing Office, 1913) made clear, one man effectively controlled money and credit in the United States: financier J. P. Morgan. The motive behind the design and implementation of the Federal Reserve System was to break up the concentration of control of money and credit centered in New York City, yet leave full control in the hands of the private sector.

Thus, instead of a single central bank, the Federal Reserve System was designed as a network of twelve regional development banks. As we have seen, this was similar to a proposal made by Congressman George Tucker of Virginia in 1839, for a network of national banks to provide discounting services for the private sector, thereby regulating the value of the currency without direct State control. (George Tucker, The Theory of Money and Banks Investigated. Boston: Charles C. Little and James Brown, 1839.)

As "lenders of last resort" for the private sector, the regional Federal Reserve banks were to stand ready to supplement — never to replace or control — the supply of private sector money that provided and still provides the bulk of the money supply for the economy. Built into the system was the assumption that long-term capital investment is a matter for the private sector to deal with. The Federal Reserve was there to ensure that the currency would be stable, would always pass at par, and that short-term (90 day or less) liquidity needs of the economy would be adequately provided for without inflation or deflation. Short-term liquidity needs would be met by means of an elastic currency maintained by rediscounting qualified industrial, commercial, and agricultural paper issued — discounted — by member banks, supplemented when necessary with open market purchases of similarly qualified commercial paper issued by non-member banks and individual industrial, commercial, and agricultural enterprises.

Clearly the original mission of the Federal Reserve is not inconsistent with the Just Third Way, especially as applied in Capital Homesteading. There are, however, certain changes that need to be made in order to make the Federal Reserve — an integral part of a well-run financial system and sound economy — into something that is fully consistent with the Just Third Way and Capital Homesteading.

The task is twofold: 1) reform the Federal Reserve so as to restore it to its original mission to "furnish an elastic currency, to afford means of rediscounting commercial paper, [and] to establish a more effective supervision of banking in the United States." 2) Within the parameters established by adherence to the principles of sound finance and banking found in the principles of the Banking School (exemplified by Say's Law of Markets and the real bills doctrine), restructure the operations of the Federal Reserve to conform to the demands of the Just Third Way, especially as found in the Capital Homesteading proposal.

Of the necessary reforms to accomplish our goal, we have already covered the need to stop all monetization of government deficits, replace traditional collateral with capital credit insurance and reinsurance, establish a two-tiered interest rate, mandate a 100% reserve requirement for commercial banks, and restore the autonomy of the regional Federal Reserve banks. All of these reforms, however, are largely directed at restoring the original function of the Federal Reserve, or in eliminating certain functions that have managed to get themselves added but that have nothing to do with the original purpose for which the Federal Reserve was established. We now have to consider what new provisions need to be put in place so as to bring the structure and operation of the Federal Reserve System into conformity with the Just Third Way and meet the demands of a Capital Homesteading program.

As we have already noted, the Federal Reserve was intended to provide for the short-term liquidity needs of the private sector. For reasons we need not get into at this point, the function of the Federal Reserve was more or less gradually changed from its inception in 1913 from being the lender of last resort to the private sector, to acting as the chief financier of federal government operations — the lender of first resort to the State. Ironically, the central bank of the United States was carefully designed to try and prevent the federal government — or any other level of government — from being able to monetize its deficits. The dangers of allowing the State to avoid the accountability that direct taxation naturally affords were obvious to the framers of the Act, as was the more immediate danger represented by concentrated control over money and credit that the Act was designed to break up.

In order to emancipate humanity from what Kelso and Adler called "the slavery of savings" (meaning, of course, past savings, not the future savings on which financial feasibility of any viable capital project relies), the Federal Reserve needs to stop all financing of government debt, and begin financing all new capital formation by monetizing the present value of future marketable goods and services by rediscounting qualified industrial, commercial, and agricultural paper discounted by the commercial banking system.

We specify future marketable goods and services in this discussion because of the need to extend the term for loans made to finance new capital formation in a way that creates new owners of that capital. The Federal Reserve was established in part to provide liquidity for the private sector by monetizing short-term loans backed by the present value of existing inventories of marketable goods and services — which inventories already belong to the owners of the capital that produced those inventories.

This does not mean that we advocate that the Federal Reserve not resume rediscounting of short-term qualified paper. This function remains critical to supplying adequate short-term liquidity needs of the private sector, even if it does not create a single new owner. We advocate replacing the present long-term financing of government deficits with long-term financing of new capital formation in ways that create new owners of the new capital.

The necessity of monetizing the present value of existing inventories of marketable goods and services is easily demonstrated. The present value of existing marketable goods and services can be — and frequently is — monetized by drawing bills on the present value of those goods and services. These bills can be used as — and, in point of fact, are — money. This private sector money — as we have seen — accounts for approximately 60% of all financial transactions in the American economy. These bills can be discounted at a commercial bank and exchanged for currency or demand deposits, but that is not, strictly speaking, necessary in order for the bills to circulate as part of the money supply. Frequently this private sector money circulates in the economy without the intermediation of financial institutions.

In accordance with Say's Law of Markets, these bills, backed by the present value of existing marketable goods and services belonging to the producer of the goods and services/drawer of the bill, are the primary source of the aggregate effective demand by means of which the producer/issuer purchases the marketable goods and services produced by others. The real bills doctrine therefore provides the mechanism by means of which Say's Law of Markets operates so that supply can create its own demand, and demand its own supply. Obviously, then, in order to ensure that adequate effective demand is distributed throughout the economy, ownership of the means of production, whether labor, land, or capital, must also be broadly distributed throughout the economy.

This answers the objection that some critics of binary economics insist on raising. Locked into the assumptions of the Currency School that defines "money" solely in terms of State-issued coin and currency, and (usually) bank-created demand deposits, they assert that if all "money" is created only to finance new capital formation, then the money supply will necessarily dwindle and, finally, disappear as the capital formation loans are repaid. This is because, as they claim, the bank necessarily takes back more money in the form of interest than it created to finance the new capital in the first place.

As should immediately be obvious, even if the assumptions of the Currency School were perfectly valid and the money supply consisted exclusively of State-issued coin and currency, and bank-created demand deposits, the objection is without foundation. A bank does not cancel or destroy the amount it receives over and above the amount it created, that is, the original loan principal less the bank's discount. Instead, it books the amount it receives in excess of the original loan principal as revenue, and uses the revenue to meet costs, expand operations, and distribute profits. The money does not disappear, but reenters circulation as the bank expends it.

Further, the process is going on all the time. Even if the money supply were dwindling away as such critics assert, there would be a continual creation of new money as the bank participated in the financing of new capital projects and the economy grew. The objection assumes 1) an economy in which there is exclusive reliance on existing accumulations of savings to finance capital formation, 2) the money supply exists exclusively of bank- or State-created money, and 3) a condition of total economic stagnation — none of which even remotely resembles reality.

In any event, the bottom line is that the money needed to clear existing inventories of marketable goods and services can be created as needed by discounting bills backed by the present value of those inventories at a commercial bank, with the commercial bank immediately rediscounting the bills at the regional Federal Reserve in accordance with the 100% reserve requirement. Such transactions are necessarily short-term, as financing operations in this manner usually requires redeeming a bill within 90 days, with shorter terms more usual. Our interest at this point is to ensure that there is adequate liquidity to finance new capital formation, and that such financing results in the creation not just of new capital, but of new owners of that capital. This requires that the Federal Reserve rediscount bills with terms longer than 90 days.

Fortunately, there are precedents. Obviously the mounting federal deficit and the nearly $1 trillion of M1 and M2 backed by government debt held by the Federal Reserve is an example of effective long-term financing, regardless of the term of any specific government debt instrument. There is no real difference between extending long-term credit for fifty or more years, and extending short-term credit that is automatically refinanced every 90 days for generations. Realistically speaking, the Federal Reserve has effectively financed federal government deficits with loans that have been outstanding now for nearly a century — a century and a half, if we include government debt dating from the American Civil War that backed the note issues of the national banks and which were assumed by the Federal Reserve in the 1920s and 1930s.

Switching to private sector loans that have an asset rather than debt backing, and which have terms of no longer than ten years on the average would have a number of obvious advantages. One, the currency would rapidly change from being debt-backed to being asset-backed. Two, the replacement of indefinite term government loans with definite term private sector loans is clearly more financially prudent. Three, government loans are backed only by the power that the State has to collect taxes at some vague time in the future, while private sector loans collateralized with existing inventories or capital credit insurance are guaranteed to pay off, one way or another, within the specified period of time.

There is, however, a much better precedent — and we do not refer to the approximately $1.2 trillion in "toxic" mortgage-backed securities that the Federal Reserve purchased in recent years in direct contravention of the provisions of the Federal Reserve Act that prohibit the central bank from dealing in speculative securities. The inadvisability of these purchases is demonstrated by the panic that spread rapidly when it was announced that a few members of the Federal Reserve Board of Governors were considering thinking about divesting the Federal Reserve of some of its toxic holdings. ("Several Fed Members Favor Selling Mortgage Assets Soon," CNBC, 04/23/10). Within the current economic and financial framework far removed from the common sense of binary economics, a sell-off would drive up interest rates and depress the housing market, triggering inflation and stalling the recovery. It would be much better if the Federal Reserve had concentrated on production, especially production in which everyone participates both as owners of labor and as owners of capital.

Financing capital formation, democratic or otherwise, would require that the Federal Reserve extend credit for such purposes for longer terms than the standard 90 days. This addition to the functions of the Federal Reserve is in conformity with sound principles of finance and the theory and practice of commercial banking, especially as detailed in Moulton's The Formation of Capital (op. cit.). As Moulton expanded on this in a later analysis,

The commercial banking system has always been an important source of intermediate and long-term, as well as short-term, business credit. Although the commercial banks nominally made loans in the form of short-term loans, by means of extensions and renewals, as well as by demand loans of indefinite duration, they furnished a substantial part of the capital requirements of small and developing enterprises. (Harold G. Moulton, George W. Edwards, James D. Magee, and Cleona Lewis, Capital Expansion, Employment, and Economic Stability. Washington, DC: The Brookings Institution, 1940, 152-157.)

Moulton noted that the usual duration of "term loans," as distinguished from short-term loans, was five years, although ten years was not unusual (ibid., 152), depending on the type of business and the asset being financed. As Moulton noted, "Term loans are made for a wide variety of purposes. They include the provision of additional general working capital; the purchase of machinery and equipment; and the liquidation of trade credits and bank loans." (Ibid., 153.)

Further, term loans enjoy certain advantages over bond issues. For example, a term loan of even five to ten years is both cheaper and more flexible (ibid., 154) than a standard bond issue of twenty or more years. Bond issues normally incur high flotation costs, and are subject to premiums and discounts with the manipulation of interest rates that seriously affect the ability of a business to raise money through the issuance of bonds.

It is important not to confuse a "bond discount" with the practice of commercial bank discounting of term loans and similar paper. The former reflects a change in the present value of the bond itself to adjust for the bond bearing an interest rate below the market. The latter is the fee charged by the financial institution for monetizing the present value of the assets behind the term loan, and has no effect on the face value of the loan contract.

Term loans are also more advantageous than a bond issue because loans are usually repaid in installments, while a bond issue is usually redeemed on maturity. A business can, of course, establish a sinking fund to retire a bond issue, or add a call feature to allow gradual redemption, but this is not required, and in any event adds administrative costs that at times can be very significant. Gradual liquidation of a liability lessens the danger that a large principal obligation will come due at an inconvenient time (e.g., during an economic downturn), while a term loan can be liquidated in full on any of the payment dates.

Further, Moulton pointed out that a banker responsible for making a term loan would ordinarily keep a close eye on the financial position of the company. As Moulton remarked, "While continuous advice from the [commercial] banker may at times be irksome, it is likely to be helpful from the standpoint of maintaining sound credit conditions." (Ibid.) All a business is likely to get from an investment bank that floated a bond issue is a bill for services. Moulton concluded that, "The extension of commercial bank credit for intermediate and fixed capital purposes has a legitimate place in banking operations." (Ibid.)

Of course, such a presumed departure from tradition was not without controversy. "Those who adhere to the old conception of commercial banking as being properly related only to the financing of the production and distribution of goods look upon it as a dangerous innovation which threatens to undermine the safety of the commercial banking system." (Ibid.) Not surprisingly, Moulton countered this argument by pointing out that extending the term of commercial bank loans for the purpose of financing intermediate and fixed capital was hardly an innovation, dangerous or otherwise, as it had been standard (if unacknowledged) practice for centuries.

In any event, the Federal Reserve was there to ensure that the commercial banking system always had sufficient reserves to meet short-term working capital needs. (Ibid.) Moulton pointed out that the risks involved in extending the term of loans and rediscounting them at the Federal Reserve entailed far fewer risks than the "more informal methods" previously used by commercial banks, in which short-term accommodation ostensibly for working capital needs became de facto long-term financing by the simple expedient of continually refinancing the loans as they came due. (Ibid., 155.)

Still, Moulton's analysis required that the Federal Reserve be specifically empowered to rediscount qualified industrial, commercial, and agricultural paper for terms of longer than 90 days. Extension of the term of qualified paper was made under an act passed on June 19, 1934 (73 Cong. 2 sess., 48 Stat. L. 1105). Under the terms of the act, the Federal Reserve was granted the power to make loans with terms of up to five years directly to private sector companies, bypassing the commercial banking system and the financial markets. (Ibid.)

Making such intermediate term loans directly to businesses represented two departures from the customary usages of the Federal Reserve. One (as we already noted), the Federal Reserve was only supposed to make short-term (90 days or less) working capital (commercial) loans. Two, the Federal Reserve was only supposed to rediscount loans made by member banks. Four conditions were laid down before such loans could be made:

• "The circumstances must be exceptional.

• "The business must be an established one and be unable to get the accommodation on a reasonable basis from the usual sources.

• "The loan must be for the provision of working capital.

• "The maturity must not be over five years." (Ibid., 155-156.)

The third condition was (re)interpreted rather liberally. Moulton pointed out that while a little over 70% of the loans made under the act were, in fact, made for working capital, a significant proportion were made to finance new capital formation as well as other purposes. (Ibid., 156.) Significantly, the act also provided that a Federal Reserve bank could discount or purchase similar loans made by any financial institution within its district on the same terms, with the added stipulation that the financial institution making the original loan had to bear 20% of any loss. (Ibid.; cf. the proposal for capital credit insurance and reinsurance, in which a lender should not be permitted to insure for the full amount of the loan.) This tended to confirm Moulton's claim that the commercial banking system, backed up by the Federal Reserve, was well equipped to handle intermediate and long-term financing without danger or by assuming an undue amount of risk.

Evidently the authorities agreed. In 1938, the Board of Governors of the Federal Reserve issued new regulations permitting member banks to purchase loans having a maturity as long as ten years, and to grant generous repayment schedules by permitting no repayment of principal in the first year, and 75% over the term of the loan. The new regulations were issued with the concurrence of the Comptroller of the Currency and the Federal Deposit Insurance Corporation. (Ibid.) Implicit in the new regulations was the ability of commercial banks to rediscount such loans at the Federal Reserve, for it would make no sense to permit commercial banks to make such loans, and yet deny them eligibility.

Thus, it is no great innovation or even drastic change to require that Federal Reserve banks extend the term of loans that qualify for rediscounting — and to include among the qualifications that such loans must be made in a way that extends ownership of the new capital so financed to people who currently lack ownership of the means of production.

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Own the Fed — the Program, Part XIII: Restoration of Autonomy

One of the cornerstones of the Just Third Way is the principle of subsidiarity. Subsidiarity is the principle that those individuals and institutions most closely involved at a particular level of the common good are charged with the immediate responsibility of monitoring and reforming the level of the common good in which they live, work, function, and so on.

The late social philosopher Rev. William Ferree divided this principle of subsidiarity into two parts. One, no higher organization may arrogate to itself a function which a lower organization can adequately perform. Two, no lower organization may usurp a higher one for its own particular purposes. In terms of "Justice-Based Management," subsidiarity refers to the delegation of decision-making power over a particular area of operation by those working directly in that area.

More simply put, subsidiarity does not mean that the State does whatever the individual cannot do for him- or herself, or that the individual must be free from any collective influence or demands of society. On the contrary, subsidiarity is an acknowledgement of humanity's political nature, a possibly unique combination of individual and social creature. Consistent with its political nature, humanity tends to live in consciously organized and structured groups that protect individual human rights. Aristotle used the example of the City-State — the polis, hence political. Human beings typically join together in free association — groups — to address those situations and tasks that individuals cannot handle alone and unaided, but without prejudice to individual rights, personal sovereignty, and human dignity.

The State's role is not to step in to provide individual or even group needs, mediately or immediately, but when confined to its proper role maintains and safeguards the institutional environment within which individuals and groups meet their own needs. The institutions themselves are designed and built by individuals coming together in free association, but maintained and safeguarded with the assistance of the State, which enforces the law through its monopoly on the instruments of coercion. In this understanding of subsidiarity, State assistance and direct government provision of individual goods is at best an expedient, to be tolerated when necessary, but which must be replaced as soon as possible with a properly restructured institutional environment so that people can once again take over responsibility for themselves and their dependents.

This correct understanding of the principle of subsidiarity was built into the original plan of the Federal Reserve System in 1913. Nor was this an accident. The financial and political history of the United States demonstrates a deep and abiding suspicion of concentrated power of any kind, but most especially of concentrated economic power. The role that a well-regulated commercial banking system necessarily plays in the economic development of a country, and thus the need for a centralized regulatory body independent of political forces has been widely — even wildly — misunderstood in the United States from colonial times down to the present day. The eagerness to dismantle the First and Second Banks of the United States, the structuring of the National Bank Act of 1864, the manner in which the financing of the American Civil War and the First World War were bungled, the virtual hijacking of the Federal Reserve to finance the New Deal and then the Second World War, the Employment Act of 1946, the Great Society, the current spate of bailouts and stimulus packages — the list seems virtually endless — all serve to illustrate how a vital economic and financial tool has been grossly misunderstood and therefore misused. That this has been to the detriment of the economic as well as political stability of the United States is obvious from the chaos that now plagues this country and the rest of the world.

Despite all the problems, however, subsidiarity has been a cornerstone of restoring the application of the natural moral law as found in the principles of the Banking School to the financial system and to the economy as a whole. We might even be tempted to call the principle of subsidiarity the philosophical basis of binary economics' reliance on "harmony" (social justice), the feedback principle that balances and restores participation and distribution within the economic system. Louis Kelso and Mortimer Adler called this the "principle of limitation." In accounting terms, the principle of subsidiarity is a necessary aspect of a sound system of internal control, as its application builds accountability into the system.

The need for a "decentralized central bank" was perceived early on, soon after the failure of the Second Bank of the United States in the 1830s. In what economic historian Joseph Dorfman described as presaging the Federal Reserve System, Congressman George Tucker in The Theory of Money and Banks Investigated (op. cit.), his in-depth study of money and banking in America, proposed a competitive system of national banks, rather than a single monolithic entity, regardless how many branches it might have. As he explained, "Whatever may be the benefits of a national bank, they would all seem to be increased by having more than one, except that the profits to the shareholders would be somewhat diminished." (Ibid., 328.)

Tucker listed three distinct advantages to be gained from such an arrangement. One, although the "power and influence [of having a single national bank with large capital] have been greatly overrated by popular jealousy and party antipathies, yet, as it is still honestly believed by a large mass of our citizens to be formidable, their fears are entitled to respect, and should be quieted if possible." (Ibid.) In a statement that many of today's politicians might find inconvenient or uncomfortable, Tucker reminded us that, "The feelings of a large portion of the people will never be disregarded by a wise and a just government, even when they are founded on prejudice." (Cf. Dicey, Lectures on the Relation Between Law and Public Opinion in England During the Nineteenth Century, op. cit.)

That is, every leader should respect the basic institutions and mores of the people — even (or especially) when they believe them to be wrong or contrary to nature. No law can be effective or have the desired result unless the people affected accept the law, both as a law and in the spirit that guided its enactment. Ultimately, people cannot be ruled for long by simple fiat; at some level they have to accept and support their own government. True governance consists not of ordering people about, but in leading them. Changing what Dicey called public opinion requires careful study and a deep understanding of the natural moral law discerned in human nature, and an ineradicable part of that nature. Then people must be educated to accept a desired change. After that, it becomes possible to take steps — most usually and most effectively by the people themselves acting in free association — to restructure the relevant institutions of the social order so that the desired behavior becomes not only preferred, but possible. This is the point of what Rev. William Ferree called "the act of social justice." (See William J. Ferree, S.M., Ph.D., The Act of Social Justice. Washington, DC: The Catholic University of America Press, 1943.)

Two, "the plan [of having a number of national banks] would secure to the public the benefit of competition in all those functions in which a national bank has any advantage over state banks; as in domestic exchange, in furnishing a more uniform currency; and in fiscal services to the government, both at home and abroad. Their profits, then, on the purchase of bills, and the sale of their own drafts, would not only be less than would be charged by the state banks, but at the lowest rates at which they could be afforded." (Tucker, op. cit., 328-329.)

Here, then, is a partial answer to Henry Simons's difficulty about vesting monopoly power over money and credit in a single central bank or even network of national banks controlled by a central monetary authority: establish a number of autonomous institutions filling the same role so that they necessarily compete as well as provide essential redundancy in the system. As Tucker concluded in his final advantage to having two or three national banks in place of one,

The two or three national banks would be salutary and effective checks on each other. We have seen that the state banks, whose excessive issues are so effectually controlled by a national bank, are also a reciprocal check on the latter; but their power could never be so great, both from defect of concert and unity of action, and for want of the important aid that would be afforded by the funds of the government. The national banks, thus equal in capital, in credit, and resources, in all parts of the union, would give the public the same security against the redundant issues that a single national bank has hitherto afforded against those of a state bank; and thus a further answer could be given to those who have objected to a national bank, that, while it restrained the operations of the state banks, it was unrestricted itself. (Ibid., 329.)

Tucker's proposal was substantially different from the system of national banks established by Salmon P. Chase during the American Civil War. The most obvious difference, of course, is that the system established under the National Bank Act of 1864 was modeled on Sir Robert Peel's Bank Charter Act of 1844. Tucker's proposal clearly assumed that the primary purpose of a commercial bank — national or otherwise — was discounting bills. The orientation of the British Bank Charter Act and the American National Bank system, however, was completely past savings-based, as is clear from Bagehot's analysis of the financial markets in Lombard Street (1873). There was no acknowledgment of the need of the private sector for a money supply that could expand and contract as necessary to match the production of marketable goods and services in the economy, and linked directly to production through the institution of private property.

The dangers of concentrated control over money and credit became painfully evident with the Panic of 1907. In an effort to keep their power, a number of movers and shakers in the American financial and political world under the leadership of Senator Nelson W. Aldrich of Rhode Island met at Jekyll Island in Georgia in November of 1910. Although it has entered conspiracy lore and legend, the Jekyll Island meeting was ultimately ineffectual. As Moulton related the story,

The Aldrich bill, resulting from the investigations of the monetary commission, was presented to Congress in January, 1911. In brief, this bill provided for a new banking organization modeled rather closely after the central banking systems of Europe; but because of American opposition to centralization of power, particularly financial power, and because of the unfortunate experience in our early history in connection with the Second Bank of the United States, it was felt that a bill proposing the establishment of a central bank would have no change of becoming a law. Accordingly, resort was had to camouflage and it was proposed to establish a national reserve association, with headquarters in Washington and with branches in various leading financial centers throughout the land. The Aldrich bill met with extremely vigorous opposition, however, and there was at no time much chance of its enactment into law. While embodying many excellent features, it also had certain important defects; moreover, it looked suspiciously like "un-American centralization of power." With the return of the Democratic party to power in 1912 it was obvious that a new approach was essential. Eventually the Federal Reserve system, providing for democratic organization and decentralized control, was evolved. (Moulton, Financial Organization and the Economic System, op. cit., 344.)

Interestingly enough, the Federal Reserve and the income tax, far from being the result of a hidden conspiracy, were due to the efforts of the Democratic Party to expose the machinations of people like J. P. Morgan, especially their responsibility for the Panic of 1907. In 1912, soon after the Democrats gained power, Congress authorized the formation of a committee to investigate concentration of control over money and credit. Under the direction of Congressman Arsène P. Pujo of Louisiana, the committee's investigations focused on problems seen in clearinghouse associations, the New York Stock Exchange, and — of course — the concentration of control of money and credit. Not surprisingly, the committee reported that,

Your committee is satisfied from the proofs submitted, even in the absence of data from the banks, that there is an established and well-defined identity and community of interest between a few leaders of finance, created and held together through stock ownership, interlocking directorates, partnership and join account transactions, and other forms of domination over banks, trust companies, railroads, and public-service and industrial corporations, which has resulted in great and rapidly growing concentration of the control of money and credit in the hands of these few men. (U.S. Congressional House Committee on Banking and Currency, Report of the Committee Appointed Pursuant to House Resolutions 429 and 504 to Investigate the Concentration of Control of Money and Credit, February 28, 1913, op. cit., 129.)

Even with the general refusal of leaders in the financial services industry to cooperate, the Committee found sufficient evidence that there was collusion among a small group of financiers with the goal of controlling certain key industries. The report was used to generate popular support for the passage of the 16th amendment authorizing the income tax, the Clayton Antitrust Act, and the Federal Reserve Act. Louis Brandeis relied heavily on the findings of the Committee in his book, Other People's Money and How the Bankers Use It (1914).

Far from being the result of machinations by a hidden conspiracy, these measures were intended to break up the power exercised behind the scenes by a cabal headed by the participants in the Jekyll Island meeting. In light of the subsequent "hijacking" of the income tax and the Federal Reserve System it is easy to see why a number of people might conclude that a conspiracy was at work. Nevertheless, it is clear that the Federal Reserve Act and the income tax were the result of exposing what amounted to a conspiracy. These and other measures were actually steps taken to try and ensure that a small group controlling money and credit would never again be in a position to cause social and financial disruption on the scale of the Panic of 1907.

The design of the new Federal Reserve System therefore included provisions intended to break up the concentration of control over money and credit. The primary means of achieving this goal was the establishment of twelve autonomous Federal Reserve banks to function as regional development banks without being dependent on the public sector in Washington, DC, or the private sector in New York City.

The Crash of 1929 and the subsequent depression provided the opportunity and the means by which control over money and credit was once again concentrated, this time to an even greater degree than before the Panic of 1907. As Moulton commented, "In the years since 1929 the Federal Reserve system has undergone a considerable transformation, designed to strengthen the control of the central Reserve officials over the banking system." (Moulton, Financial Organization of the Economic System, op. cit., 407.) This development was directly contrary to one of the main problems that the Federal Reserve was designed to counter. As Moulton explained, "The original organization, in the interests of democratic control, had vested large powers in the Reserve banks themselves." (Ibid., 409.)

Thus, each Federal Reserve bank was empowered to engage in open market operations — primarily in privately issued securities, not government debt! — and to set their own discount rates as local conditions and prudence dictated. Consequently, because the financial center of the country was still New York City, the power and prestige of the governor of the Federal Reserve Bank of New York far exceeded that of the Board of Governors in Washington, DC. As Moulton explained,

The truth is that the Federal Reserve Bank of New York tended to dominate the policies of the system. The Governor of the New York bank not only virtually controlled open market activities, but it was he rather than the Washington officials who conducted negotiations and worked out cooperative plans with the central banks of other countries. (Ibid., 409-410.)

It comes as no surprise that the first thing that the Federal Reserve officials in Washington did when they got the chance offered by Roosevelt's New Deal was to move to consolidate control over the system. The Board of Governors of the Federal Reserve therefore made five substantial and overreaching changes in the system that changed the whole nature of the central bank:

• Only the Board of Governors would have jurisdiction over all dealings and relationships between Federal Reserve banks and foreign banking institutions or their representatives.

• Regional Federal Reserve Banks were forbidden to engage in open market operations except as specifically prescribed by the newly established Open Market Committee in Washington, thereby taking away from the regional Federal Reserve banks the power, whatever its objective value or justification, to engage in what had become the principal tool for implementing monetary policy.

• Discount rates, despite a nominal control by the regional Federal Reserve banks, were to be set by the Board of Governors in Washington.

• The Board of Governors in Washington asserted a previously unheard-of right to withhold supplies of Federal Reserve Notes from any regional Federal Reserve bank and to refuse accommodation to any regional Federal Reserve bank when such a move was determined to be necessary to maintain sound credit conditions.

• The power to modify reserve requirements of commercial banks was taken away from the regional Federal Reserve banks and vested in the Board of Governors.

The original justification for the establishment of the Federal Reserve System was thereby overthrown. Moulton, evidently more astute than many of today's commentators and academics who continue to labor under the delusion that the Federal Reserve is an independent central bank, gave a somewhat acerbic analysis of these developments, which he clearly ascribed to the growth of fascism. As he commented:

Under the new organization, as we have seen, the powers of the Board of Governors have been greatly expanded, thereby circumscribing the independence of action of the member banks; and at the same time the Board of Governors has been placed more definitely under political control. This is accomplished through that provision of the law which makes the governor of the Board removable at the will of the President.

This shift is a reflection of the philosophy that not only is it a proper function of the Government to assume control over the entire credit system, but that only the Government can be depended upon to exercise such control in the interest of the public welfare as a whole. This conception appears to be the result of two factors — the failure of the former system of control to prevent financial crises, and the greatly increased importance of government fiscal and financial operations in the larger scheme of things. Whether the new alignment will be able to avoid the weaknesses disclosed in former periods of political control, time will demonstrate. (Ibid., 417.)

Details have changed, but the belief that complete control of the financial system is a proper function of the State has only increased, having become a virtual obsession in the 21st century. Proper application of the principle of subsidiarity, however, dictates that this situation not only should, but must be reversed. Consequently, the following reforms in the current operation of the Federal Reserve System should go a long way towards restoring the autonomy of the regional Federal Reserve banks and in breaking up the concentrated power that the Board of Governors in Washington, DC now exercises over the system. While there may be other measures developed as the proposal is refined, these should be sufficient to begin the process.

One, as regional development banks responsible for the regulation of money and credit within a specific district, each local Federal Reserve bank must have the power to negotiate directly with foreign central banks and their representatives. A mandatory 100% reserve requirement and prohibition against monetizing government deficits will, of course, greatly restrict the power that even the Board of Governors now enjoys with respect to foreign central banks with respect to dealing in foreign government securities and foreign currency exchange. Restoration of this provision may, therefore, be largely symbolic, but it is important nonetheless to emphasize regional autonomy under the principle of subsidiarity.

Two, each regional Federal Reserve bank must have the power to engage in open market operations within its district fully restored. The only change — effective for the system as a whole, and not to be construed as a punitive measure against the regional Federal Reserve banks — would be an absolute prohibition against dealing in any form of government securities, foreign or domestic, primary or secondary, local, state, or federal. Open market operations were only ever intended to supplement rediscounting of qualified industrial, commercial, and agricultural paper as the primary monetary tool of the Federal Reserve System. As a powerful tool directly affecting the market, and thus easily misused, open market operations must be restricted to the original intent of the institution.

Three, each regional Federal Reserve bank must have the power to set the discount rate in its own region. The discount rate is not an arbitrary figure set by the whatever the Board of Governors believes will have the desired effect on money and credit (and thus employment), but should logically be set at a level to cover the cost of creating new money and the cost of administering the system. Obviously this cannot be arbitrary, but determined by the actual costs in each region, which should differ, depending on local conditions.

Finally, four, the Board of Governors must not be permitted to withhold supplies of notes or, more importantly, refuse accommodation to any regional Federal Reserve bank, i.e., refuse to allow other regional Federal Reserve banks to rediscount paper from any other regional Federal Reserve bank. The ability of regional Federal Reserve banks to deal freely among themselves in direct response to the need for liquidity in a particular region is an important internal control mechanism to ensure parity of currency among the different regions and the country as a whole. It should be market-determined, not controlled by a central authority that may be influenced by political motives rather than by the needs of the private sector.

Restoring the autonomy of the regional Federal Reserve banks should, therefore, advance a sound reform of the central banking system in the United States. Consistent with the principle of subsidiarity, restoration of autonomy would make the creation of new money for qualified industrial, commercial, and agricultural investment a local affair rather than something to be decided by a centralized authority subject to over political influence.

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Own the Fed — the Program, Part XII: 100% Reserves Behind the Currency

As effective as the two-tiered interest rate should be in discouraging speculative and non-productive uses of credit in money creation, it is not sufficient in and of itself to prevent money creation for all nonproductive spending. The two-tiered interest rate will not stop induced inflation or deflation, or other manipulation of the money supply for dubious political ends. A more just, market-based interest structure needs to be bolstered by other aspects of the system, especially reserve requirements.

This is because under fractional reserve banking individual commercial banks retain the power to create money for any purpose whatsoever. There is no way to prevent this in all circumstances, for the fractional reserve requirement regulates only the amount of money that a commercial bank can create, not the quality of the loans that back the money. Under fractional reserve banking, as long as a bank has sufficient reserves, the quality of the loans made by the bank is to a large degree a matter of subjective opinion of the financial institution, not a determination by an independent entity based on more objective market criteria. Fractional reserve banking thus violates essential principles of internal control. Regulation of the quality of loans made by commercial banks under fractional reserve banking relies on individual commercial banks adhering to rules and regulations imposed from outside the system — and such external controls as well as their enforcement are often heavily influenced by both political considerations and public opinion.

Capital credit insurance addresses the problem of the quality of loans made. Nevertheless, while insurance provides independent, third party verification of a transaction (assuming proper separation of function within the financial services industry), capital credit insurance is only a single added layer of scrutiny. Requiring immediate and mandatory rediscounting at the Federal Reserve of all loans extended by commercial banks to finance new capital formation and present working capital needs would add another layer of scrutiny. Mandatory rediscounting would impose a 100% reserve requirement, that is, all demand deposits would be backed 100% by cash or commercial bank demand deposits at the central bank.

Mandatory rediscounting would also ensure that all new money is issued at par with all other new issues, and all existing issues remain at par. This is one of the primary tasks of a central bank. Immediate rediscounting would ensure that the money supply always reacts virtually instantaneously with changes in the liquidity needs of the economy, thereby avoiding the lag time often associated with attempts by the federal government to manipulate the economy through changes in monetary and fiscal policy.

Commercial banks would continue to have the power to make loans for speculative purposes, consumer spending, and to finance government deficits. All loans made for such purposes, however, would necessarily come out of existing reserves, that is, out of the commercial banks' capitalization, retained earnings, and accumulations by savers maintaining depository accounts. Whether a commercial bank should make loans for such purposes out of existing reserves, of course, is a matter for State regulators, the board of directors, the shareholders, and common prudence to decide.

A commercial bank would, in essence, function as a deposit bank instead of an issue bank when making loans for non-productive uses out of existing reserves. It might be that reenactment of Glass-Steagall or legislation along similar lines, as well as common sense, would result in increased specialization in the financial services industry, and thus in commercial banks restricting their activities in these areas. Commercial banks would have enough to do in carrying out their unique function: monetizing the present value of existing and future marketable goods and services, thereby providing liquidity for the productive private sector.

It is important to note again that capital credit insurance, the two-tiered interest rate, and now the 100% reserve requirement apply only to commercial bank credit. Such reforms do not affect what we have termed "private sector money" — that part of the money supply represented by bills that circulate in the economy that are "disintermediated," that is, not discounted at a commercial bank, rediscounted at the Federal Reserve, or purchased by the central bank in open market operations. As late as 2008, this private sector money accounted for approximately 60% of the total money supply, and in the Jacksonian era of the early 19th century, a period in which the power of the central government was narrowly circumscribed, approached 95%. (This figure is based on the analysis by George Tucker in his 1839 book.)

The 100% reserve requirement is not a new idea. Deposit banks have always had a 100% reserve requirement for the simple reason that they are structurally incapable of loaning out more money than they have on deposit. During the 1930s there was serious consideration given to abolishing the commercial banking system by transforming all commercial banks and the Federal Reserve banks into banks of deposit, and restricting all money creation to the United States Treasury, to be backed 100% by government debt.

The proposal was popularly called "the Chicago Plan." Henry Simons (1899-1946), generally considered the founder of the Chicago School of economics — the Monetarists — developed the original proposal. The basic idea was that all commercial banks that functioned as issue banks would be abolished, the Federal Reserve's power to create money would be eliminated, and deposit banks would provide all the financing necessary for economic growth and development. (Henry C. Simons, "A Positive Program for Laissez Faire," Economic Policy for a Free Society. Chicago, Illinois: The University of Chicago Press, 1947, 62.) All money would be backed 100% by federal government securities held in National Banks that would function as a Sub-Treasury system. (Ibid., 62-63.)

In essence, Simons's proposal was to reestablish the National Banking system organized under the National Bank Act of 1864. The Federal Reserve System would be reorganized as a network of national banks, not a central banking system under the Federal Reserve Act of 1913. Even "national bank" is incorrect in this context, for a national bank is by definition a type commercial bank, and commercial banks have the power to create money.

To get around Fullarton's objections to the illogic of assuming that a fixed amount of currency (and demand deposits) could adequately meet the needs of the economy (John Fullarton, On the Regulation of Currencies of the Bank of England. London: John Murray, 1845, 3-4) and provide for an elastic currency, Simons proposed the formation of an independent regulatory body ("National Monetary Authority") that would determine the amount of new money to be created (or canceled) each year. (Simons, op. cit., 63; Norman Angell, The Story of Money. New York: Frederick A. Stokes Company, 1929, 7.) As described by Simons in his essay, "A Positive Program for Laissez Faire," the basic elements of the Chicago Plan are:

1. Outright federal ownership of the Federal Reserve banks.

2. Annulment of all existing bank charters (as of a date, say, two years in the future), and enactment of new federal legislation providing for complete separation, between different classes of corporations, of the deposit and lending functions of existing deposit banks.

3. Legislation requiring that all institutions which maintain deposit liabilities and/or provide checking facilities (or any substitute therefore) shall maintain reserves of 100 per cent in cash and deposits with the Federal Reserve banks.

4. Provision during the transition period for gradual displacement of private-bank credit as circulating medium by credit of the Federal Reserve banks.

(This implies enormous increase in the investments and in the demand obligations of the Reserve banks — i.e., long continued open-market purchases which would serve to inject the substitute credit medium and also to facilitate gradual liquidation of the investments of existing deposit banks. At the end of the transition, the Reserve banks should find themselves in possession of investments amounting to a substantial portion of the federal debt — or, perhaps, in possession of the greater part of the debt itself — thus eliminating the burden of the debt, to that extent, without taxation and without inflation.)

5. Displacement by notes and deposits of the Reserve banks of all other forms of currency in circulation, thus giving us a completely homogeneous national circulating medium.

(This implies permanent retirement of all United States notes ["greenbacks"], all silver dollars and silver certificates, all gold coin and gold certificates, and all national bank notes. Subsidiary silver might be retained [though it might better be replaced by coins of a cheaper and more durable metal]. Monetary gold would be held exclusively by the Reserve banks, in the form of bars, and utilized only for settlement of international balances.)

6. Prescription in legislation of an explicit, simple rule or principle of monetary policy, and establishment of an appointive, administrative body ("National Monetary Authority"), charged with carrying out the prescribed rule, and vested with no discretionary powers as regards fundamental policy.

7. Abolition of reserve requirements against notes and deposits of the Reserve banks, and broad grants of powers to the "national Monetary Authority" for performance of its strictly administrative function.

(The foregoing measures contemplate an economy in which the rules of the game as to money are definite, intelligible, and inflexible. They are intended to avoid both the "rulelessness" of the present system and the establishment of any system based on discretionary management. "Managed currency," without fixed rules of management, appeals to me as among the most dangerous forms of "planning." To establish, as part of a free-enterprise economy, a monetary authority with power to alter vitally and arbitrarily the position of parties to financial contracts would seem fantastic.) ("A Positive Program for Laissez Faire," loc. cit.)

The problem from the perspective of binary economics, of course, is that Simons's proposal, modeled on the British Bank Charter Act of 1844 and the United States National Bank Act of 1864, represents the logical conclusion and the highest possible development of a system based on existing accumulations of savings. Simons included demand deposits in the definition of "money," and made the currency elastic (in an arbitrary fashion that did not really address Fullarton's concerns), but his proposal was otherwise no different from the classic tenets of the Currency School. Simons implicitly rejected the real bills doctrine and assumed the necessity of existing accumulations of savings to finance capital formation.

In the system that Simons sought to reform, money created to finance federal government deficits already was and remains backed 100% by government securities. The money created through the commercial banking system by means of increases in demand deposits, on the other hand, was and is backed only partly by government securities. The rest is backed by liens on whatever collateral a borrower has put up to qualify for a loan, or in some cases only the borrower's faith and credit — an unsecured loan. The requirement that demand deposits of commercial banks be backed only partially by government securities and cash (the same thing, ultimately, given that cash in the current system is backed by government securities) is fractional reserve banking.

Simons appears to have reasoned, logically enough, that if the entire money supply could be backed 100% by United States government securities, the soundest in the world, instead of split between 100% reserves for money backed by State debt paper and fractional reserves for money backed by questionable commercial debt paper, the problem of scarce money and tight credit could be solved. To make certain that the politicians didn't seize control of the Federal Reserve, a monetary agency could be established to determine the amount of money needed in the economy. The State would issue debt paper to the authorized amount, sell it to the Federal Reserve, spend the money without having to tax people, and the free market, laissez-faire capitalist economy could take it from there.

There was, however, a serious problem with the Chicago Plan. As an adherent of free market economics, Simons was far from comfortable with turning over the money power to a monopoly, to say nothing of the lack of accountability that abolishing certain taxes would insert into the system. As Simons stated in "A Positive Program for Laissez-Faire," the 100% reserve requirement based on government debt would,

Eliminate all forms of monopolistic market power, to include the breakup of large oligopolistic corporations and application of anti-trust laws to labor unions. A Federal incorporation law could be used to limit corporation size and where technology required giant firms for reasons of low cost production the Federal government should own and operate them . . . . Promote economic stability by reform of the monetary system and establishment of stable rules for monetary policy . . . . Reform the tax system and promote equity through income tax . . . . Abolish all tariffs . . . . Limit waste by restricting advertising and other wasteful merchandising practices.

Simons, however, at least had seen (for good or ill) the various stratagems by means of which politicians had seized control of the world's central banks, even the United States Federal Reserve System. He was therefore fully aware of the necessity of devising some means to prevent the politicians from seizing control of his recommended independent monetary authority. A number of authorities viewed Simons' concerns as needless scruples: people in the Great Depression needed plentiful money and easy credit immediately. Control measures could wait; fix the problem first, and worry later whether it was the best or even the right thing to do.

The problem with immediate implementation was that Simons was very well aware of the dangers of just charging forward without implementing adequate controls, or the checks and balances Bagehot had dismissed so blithely. Simons struggled valiantly to develop some system to provide control over his system. He was, however, faced with an impossible situation, a problem that could not be solved within the paradigm in which he was operating. He was attempting to reconcile a State monopoly over money and credit with free market principles. As State ownership or monopoly and free markets are diametrically opposed, he could not do it. The laissez-faire principles supporting issue banking simply could not be reconciled with the monopolizing principles supporting State-funded deposit banking.

As devised by Simons, then, the Chicago Plan required intrusive, even overreaching State control at the same time that Simons's own principles rejected all forms of monopoly power. (See, e.g., Henry C. Simons, "Some Reflections on Syndicalism," The Journal of Political Economy. Volume LII, March 1944, No. 1, 1-25.) As he declared, "The great enemy of democracy is monopoly, in all its forms: gigantic corporations, trade associations and other agencies for price control, trade unions — or, in general, organization and concentration of power within functional classes." (Quoted in John Davenport, "The Testament of Henry Simons," Fortune magazine, Volume XXXIV, No. 1.) This presented a problem, for State control over the creation of money would impose the most powerful monopoly of all, and vest that control right where it should not be. As the Wall Street Journal pointed out, "The effect of the plan, of course, would be to concentrate the entire banking and credit function in the hands of the government." ("Powerful Support Under Way For '100% Reserve Plan'," The Wall Street Journal, 02/19/35, 6.)

Simons, of course, understood the paradox. He addressed this problem in a general way, but was never able to develop a specific proposal to prevent total State control of the economy, whether the State did so directly or by taking over the regulatory body. ("Rules versus Authorities in Monetary Policy," Journal of Political Economy, XLIV, No. 1, February, 1936, 1-30.) Despite the urging of such diverse authorities as Senator J. W. Elmer Thomas of Oklahoma, Irving Fisher, and Father Charles Coughlin, Dr. Simons refused to push for implementation of the Chicago Plan. ("Powerful Support Under Way For '100% Reserve Plan'," loc cit.; David Laidler, "Review of Meltzer's History of the Federal Reserve," Department of Economics, University of Western Ontario, (No date) 24n.) Father Charles E. Coughlin, the noted "Rosary Priest," held views on money that appeared to be derived from a more extreme understanding of the position of the Currency School. His version of the 100% reserve requirement was substantially different from that of both Simons and Fisher. (See Charles E. Coughlin, Money! Questions and Answers. Palmdale, California: Omni Christian Publications (No date).)

Using an improved 100% reserve requirement that allowed for the operation of the real bills doctrine would have solved Simons's problems. A 100% reserve requirement under binary economics and the real bills doctrine would put control over the money power back into the hands of ordinary citizens. That is, ultimate power would be vested in anyone who presented financially feasible proposals for capital formation to a commercial bank for discounting — a real bill.

Under the Capital Homesteading version of the 100% reserve requirement, a commercial bank would not keep a portion of the bank's assets on hand in the form of vault cash, demand deposits at the Federal Reserve, and federal government securities to meet fractional reserve requirements. Instead, all of the bank's assets representing loans made for qualified industrial, commercial, and agricultural capital projects would be in the form of vault cash or commercial bank demand deposits at the local Federal Reserve Bank. To avoid all possibility that the federal government would be able to circumvent the prohibition against monetizing its deficits, "reserves" would be strictly redefined to eliminate all forms of government debt from the definition.

Consequently, in order to maintain 100% reserves, all commercial banks would have to discount all loans made at the local Federal Reserve Bank. This would also force a greater level of scrutiny on the commercial banks to ensure that all loans met the financial feasibility requirements for rediscounting at the central bank. The commercial bank would otherwise risk losing its access to the discount window. This would force the commercial bank to become a savings bank (a bank of deposit), or put it out of business.

Thus, the 100% reserve requirement under the Capital Homesteading proposal of the Just Third Way is materially different from Simons's Chicago Plan. This is based on the fact that Capital Homesteading has a completely different orientation toward money creation. Under the tenets of the British Currency School, money is presumed to be created first, then savings and capital formation can take place. This was the assumption embodied in the Chicago Plan, in which a monetary authority would estimate the amount of money needed in the economy, create it, and turn it over to the banks to lend out. The sequence in money creation is presumed to be 1) create money, 2) cut consumption and save, 3) locate a project or inventory of marketable goods and services with present value, then 4) invest. As should be obvious, there is a serious danger of either inflation or deflation in this process if the monetary authority happens to guess incorrectly.

Under the tenets of the British Banking School and in accordance with Say's Law of Markets and the real bills doctrine, however, no money is or can be created until and unless a potential borrower brings a financially feasible project to the commercial bank. The present value of existing or future marketable goods and services is determined, and money is created by means of the issue of a promissory note, then invested in the capital project, after which money is taken out of the future stream of income and used to repay the loan. The sequence is 1) locate a project or inventory of marketable goods and services with present value, 2) create money to finance the project in an amount no greater than the present value of the project, 3) invest, and 4) save. As should be equally obvious, there is no danger of either inflation or deflation, as money can only be created as needed in response to existing present value.

While this is the soundest method of creating money, one thing more is needed, and is eminently feasible by using a central bank properly in the way in which it was intended. Instead of having each commercial bank be individually liable for its privately issued promissory notes, a central bank can purchase all loans made by commercial banks to finance industrial, commercial, and agricultural projects that have been properly vetted and collateralized. Thus, just as an individual borrower exchanges his or her personal credit for the less risky and more acceptable institutional credit of a commercial bank, individual commercial banks would exchange their credit for that of the nation itself by discounting all loans at the central bank.

All new money created by the extension of commercial bank credit would thus be direct issues of promissory notes not of individual commercial banks, but of the central bank. All currency and demand deposits would automatically pass at par because all would, in effect, be promissory notes of the central bank, and all promissory notes a borrower obtained from any commercial bank would be backed 100% by promissory notes issued by the central bank. This would institute an automatic 100% reserve requirement, but without the necessity of direct State control of the economy.

In conjunction with a 100% reserve requirement of this nature, the central bank would not be permitted to hold government debt, whether issued by the government and sold directly to the central bank (primary securities) or "secondary securities" issued by the government and sold to the public and subsequently purchased by the central bank on the open market. In effect, the central bank's role with respect to the State would be restricted to acting solely as a depository for State funds, and would not be able to issue promissory notes backed by government debt.

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