No, we’re not kidding. Much. This could actually work . . . at least until people catch on that the whole cryptocurrency craze is what Charles MacKay would have called an extraordinary popular delusion and a madness of crowds. This sort of thing, of course, formed the subject of MacKay’s 1841 book titled . . . well, Extraordinary Popular Delusions and the Madness of Crowds.
THE Global Justice Movement Website
This is the "Global Justice Movement" (dot org) we refer to in the title of this blog.
Showing posts with label Retiring the U.S. Debt. Show all posts
Showing posts with label Retiring the U.S. Debt. Show all posts
Wednesday, February 5, 2025
Wednesday, May 24, 2023
A Short Lesson in Bookkeeping
A proposal that has been making the rounds again is that the United States can somehow solve its debt problem by issuing trillion-dollar coins struck in platinum and use them to pay down the debt. While the proposal sounds marginally plausible if said quickly enough while moving walnut shells or thimbles around on a tabletop with a pea hidden in the crook of the presenter’s little finger — where we get the term “thimblerig” for a con man or other variety of sleight-of-hand artist — it falls apart of its own dead weight once the proposal is examined in the light of common sense and a little elementary bookkeeping.
Monday, July 30, 2012
Lies, Damned Lies, and Definitions, XXIII: Hijacking the Federal Reserve
In the previous posting in this series we saw how the Federal Reserve was carefully designed to meet the legitimate demands of all parties and interests. Properly employed, there could never again be a "currency famine" as had happened in 1893 following the Panic, nor could there be a run on a bank that would deplete its reserves, as had caused the Panic of 1907. The inelastic, currency of the National Bank system backed by government debt that had caused so many problems would gradually be replaced with an elastic Federal Reserve Note currency backed by private sector hard assets.
The idea was that the Federal Reserve would gradually purchase the government bonds that backed the National Bank Notes. They would thus assume the liability for the National Bank Notes, and replace them with "Federal Reserve Bank Notes," which would then be backed by the government bonds the Federal Reserve had purchased on the open market from the National Banks. These government debt-backed Federal Reserve Bank Notes would in turn be replaced with "Federal Reserve Notes" that would be backed by private sector bills of exchange rediscounted from member commercial banks.
This would just be a book entry, reducing the holdings of government debt and replacing government securities with private sector bills of exchange. The Federal Reserve Bank Notes and the Federal Reserve Notes were indistinguishable in appearance, so it would be unnecessary actually to print new notes — just change the backing of the notes. In this way the debt-backed currency would become an asset-backed currency.
The system was allowed to work properly for two years before World War I changed everything. Salmon P. Chase had decided to finance the Union war effort during the Civil War by issuing debt instead of raising taxes. Chase wanted to be president, and raising taxes is a very unpopular move. According to Charles Conant and other financial experts, had Chase imposed the higher taxes he was eventually forced to adopt even a year earlier, the country would have avoided most of the 600% inflation that eventually destroyed a large number of small businessmen and farmers when the government had to restore its "faith and credit" after the war, and used deflation to do so.
In 1917 the politicians made the same decision as Chase, although in their case it was so they would remain in office rather than get elected. The effect was the same, however. Borrowing money or monetizing deficits is always more popular than raising taxes, even though the potential for harm is infinitely greater, as the world has found to its cost with the current economic downturn and global debt crisis.
The First Liberty Loan issue drained virtually all available liquidity out of the system. When the Second Liberty Loan issue came out, no one had any money to buy the bonds. The commercial banks then stepped in and patriotically purchased the bonds — using the loophole in the Federal Reserve Act intended to provide for the gradual retirement of the National Bank Notes — then turned around and sold the bonds to the Federal Reserve on the "open market." A way had been found to circumvent the intended prohibition against monetizing government deficits.
#30#
The idea was that the Federal Reserve would gradually purchase the government bonds that backed the National Bank Notes. They would thus assume the liability for the National Bank Notes, and replace them with "Federal Reserve Bank Notes," which would then be backed by the government bonds the Federal Reserve had purchased on the open market from the National Banks. These government debt-backed Federal Reserve Bank Notes would in turn be replaced with "Federal Reserve Notes" that would be backed by private sector bills of exchange rediscounted from member commercial banks.
This would just be a book entry, reducing the holdings of government debt and replacing government securities with private sector bills of exchange. The Federal Reserve Bank Notes and the Federal Reserve Notes were indistinguishable in appearance, so it would be unnecessary actually to print new notes — just change the backing of the notes. In this way the debt-backed currency would become an asset-backed currency.
The system was allowed to work properly for two years before World War I changed everything. Salmon P. Chase had decided to finance the Union war effort during the Civil War by issuing debt instead of raising taxes. Chase wanted to be president, and raising taxes is a very unpopular move. According to Charles Conant and other financial experts, had Chase imposed the higher taxes he was eventually forced to adopt even a year earlier, the country would have avoided most of the 600% inflation that eventually destroyed a large number of small businessmen and farmers when the government had to restore its "faith and credit" after the war, and used deflation to do so.
In 1917 the politicians made the same decision as Chase, although in their case it was so they would remain in office rather than get elected. The effect was the same, however. Borrowing money or monetizing deficits is always more popular than raising taxes, even though the potential for harm is infinitely greater, as the world has found to its cost with the current economic downturn and global debt crisis.
The First Liberty Loan issue drained virtually all available liquidity out of the system. When the Second Liberty Loan issue came out, no one had any money to buy the bonds. The commercial banks then stepped in and patriotically purchased the bonds — using the loophole in the Federal Reserve Act intended to provide for the gradual retirement of the National Bank Notes — then turned around and sold the bonds to the Federal Reserve on the "open market." A way had been found to circumvent the intended prohibition against monetizing government deficits.
#30#
Monday, April 2, 2012
Show Me the Money!
The other day we were asked a "complex question." We don't mean that the question was difficult to answer, however. A "complex question" in logic is one that assumes the answer. The most (in)famous complex question is, "Are you still beating your wife?" Try answering that "yes" or "no" and see what happens.
Anyway, the question was, "The House [of Representatives] has rejected the budget for not including enough cuts in spending. Is this the start of sane reductions and a return to much smaller budgets?"
The "complex" part of the question is the assumption that current levels of spending are insane. We happen to agree, but the question could have been phrased better.
Anyway, the problem is that no one in power is proposing a viable alternative to government spending. As long as people assume as a given that either the government provides basic needs or we do without, there is no way out of the situation. One side is chastised for being heartless fiends who want everyone to die for want of a crust of bread or a bandage, while the other side is lambasted as brainless spendthrifts who want to take care of everyone without it costing anyone.
The fact is that government was never intended to try and take care of people's individual wants and needs, but to provide and protect the environment within which people can take care of themselves. In an emergency, of course, it's perfectly legitimate for the government to step in and redistribute enough wealth to keep people going until they can get back on their feet, but we seem now to live in a permanent state of emergency.
At the heart of the problem is the belief that only the rich or the State can own capital, and everybody else must work only for wages or receive welfare. This is because most people think that the only way to finance new capital formation is to cut consumption and save, not monetize the present value of future marketable goods and services and let the new capital finance itself. This means that only the rich who can afford to cut consumption, or the State that can simply confiscate wealth, have the ability to finance new capital.
Once we realize, however, that we can turn the present value of future marketable goods and services into money — which is what commercial and central banks were invented to do, not finance non-productive government spending — we see the way out. People who currently own no capital can become owners of the capital that is displacing them from their jobs by buying capital on credit, and paying for it with the profits received from the capital in the future.
Most new capital is financed this way, anyway, but only by people who have collateral. Replacing traditional collateral with capital credit insurance and reinsurance solves that problem. Corporations don't need to finance growth by accumulating cash. They can pay out all earnings as tax-deductible dividends (fully taxable as ordinary income to the recipient), and issue new equity to finance growth.
Once most people become capital owners by purchasing the new equity (paid for using the full stream of dividends they receive, then when the shares are paid for, using the dividends for consumption), the government need no longer provide for individual needs, including Social Security and other entitlements — that make up two-thirds of the federal budget. As more people become capital owners, entitlements can be phased out, and the savings applied to paying down the national debt.
Without a replacement for entitlements, however, all the cost-cutting and tax increases (imposed on a deteriorating tax base as jobs disappear) in the world will not help. Leaving the present system intact and fiddling with the numbers can't work. Run the numbers — without a way to finance new capital without using cuts in consumption, the economy will continue to spiral downwards, ironically just as the inflationary policies result in "gains" in the stock market.
CESJ's proposal to replace entitlements, "Capital Homesteading," has the potential to turn this situation around, but none of the candidates or incumbents is considering it.
#30#
Anyway, the question was, "The House [of Representatives] has rejected the budget for not including enough cuts in spending. Is this the start of sane reductions and a return to much smaller budgets?"
The "complex" part of the question is the assumption that current levels of spending are insane. We happen to agree, but the question could have been phrased better.
Anyway, the problem is that no one in power is proposing a viable alternative to government spending. As long as people assume as a given that either the government provides basic needs or we do without, there is no way out of the situation. One side is chastised for being heartless fiends who want everyone to die for want of a crust of bread or a bandage, while the other side is lambasted as brainless spendthrifts who want to take care of everyone without it costing anyone.
The fact is that government was never intended to try and take care of people's individual wants and needs, but to provide and protect the environment within which people can take care of themselves. In an emergency, of course, it's perfectly legitimate for the government to step in and redistribute enough wealth to keep people going until they can get back on their feet, but we seem now to live in a permanent state of emergency.
At the heart of the problem is the belief that only the rich or the State can own capital, and everybody else must work only for wages or receive welfare. This is because most people think that the only way to finance new capital formation is to cut consumption and save, not monetize the present value of future marketable goods and services and let the new capital finance itself. This means that only the rich who can afford to cut consumption, or the State that can simply confiscate wealth, have the ability to finance new capital.
Once we realize, however, that we can turn the present value of future marketable goods and services into money — which is what commercial and central banks were invented to do, not finance non-productive government spending — we see the way out. People who currently own no capital can become owners of the capital that is displacing them from their jobs by buying capital on credit, and paying for it with the profits received from the capital in the future.
Most new capital is financed this way, anyway, but only by people who have collateral. Replacing traditional collateral with capital credit insurance and reinsurance solves that problem. Corporations don't need to finance growth by accumulating cash. They can pay out all earnings as tax-deductible dividends (fully taxable as ordinary income to the recipient), and issue new equity to finance growth.
Once most people become capital owners by purchasing the new equity (paid for using the full stream of dividends they receive, then when the shares are paid for, using the dividends for consumption), the government need no longer provide for individual needs, including Social Security and other entitlements — that make up two-thirds of the federal budget. As more people become capital owners, entitlements can be phased out, and the savings applied to paying down the national debt.
Without a replacement for entitlements, however, all the cost-cutting and tax increases (imposed on a deteriorating tax base as jobs disappear) in the world will not help. Leaving the present system intact and fiddling with the numbers can't work. Run the numbers — without a way to finance new capital without using cuts in consumption, the economy will continue to spiral downwards, ironically just as the inflationary policies result in "gains" in the stock market.
CESJ's proposal to replace entitlements, "Capital Homesteading," has the potential to turn this situation around, but none of the candidates or incumbents is considering it.
#30#
Thursday, March 29, 2012
Blind Leading the Blind, II: Banking and Income
When Pippi Långstrump took up residence at Villa Villekulla with her monkey (Mister Nilsson) and her horse (Lilla Gubben — "Little Buddy," "Old Man" in some translations), she also brought with her a modicum of financial security in the form of a suitcase full of gold coins. Despite her sometimes lavish spending habits and attempts by the unscrupulous and thieving to deprive Pippi of her wealth, the suitcase always seemed full.
Not too many of us have bottomless suitcases of gold — and even if we did, gold would cease to be worth much. (Sorry, Ron, there's nothing magical about a gold standard . . . or silver, either.) Gold isn't automatically money, any more than money has to be gold. Before the flood of silver that lowered the price of that metal throughout the world in the latter half of the 19th century, most of the world was on a silver standard, not gold. There simply wasn't — and isn't — enough gold to meet the needs of commerce.
With the spread of commercial and central banking, however, the amount of gold (or silver) became, to all intents and purposes, irrelevant. The only time the precious metals became important for monetary purposes was when a country insisted on pegging its currency to a specific weight of metal and permitted "convertibility" to give the public confidence in the currency.
The ability to convert a paper currency into gold or silver does not, however, mean that the paper currency is backed by gold or silver. Convertibility simply gives the public confidence that those pieces of paper are worth what it says on the face. What backs the currency are the bills and notes "accepted" by the issuing bank or State treasury. If the bills and notes represent the present value of existing or future marketable goods and services, the currency is asset-backed. If the bills and notes represent the present value of future tax collections by the State, the currency is debt-backed.
The problem that faces us today is, how do we shift from an ubiquitous and wildly fluctuating debt-backed currency, to a stable and uniform asset-backed currency?
Reform of the Banking System. As we noted yesterday, the Federal Reserve was established in part to provide the private sector — not government — with adequate liquidity to finance capital formation whenever existing accumulations of savings or other private resources failed or were inadequate. As Dr. Harold Moulton pointed out in The Formation of Capital (1935), using existing savings to finance new capital formation actually militates against economic growth as it decreases effective demand, making new capital investment less feasible. It is far better to monetize existing and future marketable goods and services by discounting qualified paper at commercial banks and rediscounting the paper at the Federal Reserve. This would ensure an adequate supply of loanable funds by tying the money supply directly to production, and back the currency with the present value of hard assets to which it would be bound by the institution of private property.
Current projections published recently in the Wall Street Journal reveal that by the end of the current fiscal year (09/30/12), the U.S. national debt will be 72-1/2% of GDP. This means that the money supply will consist mostly of instruments backed by government debt, and less than a third in the form of instruments backed by private sector hard assets. In 1913, government debt accounted for less than 20% of GDP. (We don't have time to do the actual calculation, and most sources today hide figures by giving past data in adjusted 1990 "international dollars," so we're using the statement found in Moulton's in Principles of Money and Banking, 1916, that private sector bills of exchange at that time accounted for 80% or more of all transactions.)
One of the goals of the Federal Reserve was to replace the National Bank Notes of 1863-1913 and the Treasury Notes of 1890 — all backed by government debt — with Federal Reserve Bank Notes backed by government debt purchased from the National Banks. The Federal Reserve Bank Notes would be replaced in turn with indistinguishable Federal Reserve Notes backed by the present value of private sector hard assets as private sector asset paper replaced government debt paper as the backing of the currency.
Ignoring the confusing distinction between the identical Federal Reserve Bank Notes and Federal Reserve Notes, a similar program could be carried out today simply by prohibiting the Federal Reserve from either discounting or rediscounting of primary or secondary government securities, or engaging in open market operations in secondary government securities. The only Federal Reserve transactions permitted with respect to government securities would be to sell — not buy — its holdings.
To restore confidence in the currency and the economy, it might be advisable to retire debt held outside the United States first, followed by government debt held by commercial banks, then the Federal Reserve. Any domestic holdings by institutions and individual investors could be left outstanding for a time, as these were purchased with existing savings, and were therefore not inflationary. This, of course, requires that all efforts be focused on increasing production of actual marketable goods and services, not pumping more inflationary government debt into the system.
According to the "National Debt Clock" (accessed today, 03/29/12), more than $5 trillion in U.S. debt is held outside the United States. Assuming all exports are purchased with U.S. dollars, that means that the U.S. has to export $5 trillion more than it imports to transfer the debt "in house." Note, however, that doesn't retire the debt. It simply shifts the holders of the debt from foreign companies and countries, to U.S. producers of exported goods.
Looking again at the National Debt Clock, we see that the total national debt is a little short of $16 trillion. (Half a trillion dollars or so is an immense amount of money, but it can get spent very quickly with little or no result, as we have seen, so we'll use $16 trillion.) We remember reading somewhere or other that no government can exact more than 20% of GDP as taxes without triggering a financial meltdown. That 20% is not the tax rate. It's the percentage of GDP that can be diverted into taxation, a different thing.
Assuming that's true, the United States is going to have to produce $80 trillion in marketable goods and services to generate the $16 trillion in tax revenues necessary to retire the debt — and that's on top of the $5 trillion trade surplus required to shift the foreign debt to domestic debt. That's $85 trillion of production that we're already on the hook for . . . plus whatever is needed to keep the government running in the meantime.
Assuming that government spending gets reduced and the total government budget is maintained at around $4 trillion for all government, local, state, and federal, annual GDP must increase — without inflationary distortion — to $25 trillion every year (a 66.67% rate of growth) in order to retire the debt at a rate of $1 trillion each year, or sixteen years. Reducing the debt at a rate of $500 billion a year gives us a target GDP of $22.5 trillion (50% growth rate) and a 32-year timetable. Debt reduction at the rate of $250 billion per year would give us a target GDP of $20.625 trillion (37.5% growth) and a 64-year timetable . . . but why go on? — and we're not even counting all the promises that have been made for Social Security and Medicare and (if the administration has its druthers) Obamacare.
At current rates of growth of around 1%, these targets for growth are more than unrealistic. They're in Fantasyland. If, however, we maintain the current rate of (non) growth, but reduce the entitlements that currently take up two-thirds of the federal budget by half, or approximately $1 trillion, we can apply those savings to debt reduction, and come up with the same 16- to 32-year timetable — you know a target of $1 trillion each year simply couldn't be met without a revolt, so cut it in half and double the time needed to pay down the debt.
Plus, you can't just cut people off. By phasing out entitlements instead of going cold turkey, however, replacing Social Security, Medicare and welfare gradually with Capital Homestead Accounts, we can get a reasonable 64-year timetable (call it 65, to tie in to a lifetime's capital accumulation under Capital Homesteading), reducing the debt by $250 billion each year, starting with zero debt reduction the first year and assuming that CHA income replaces entitlements dollar-for-dollar at an even rate as people start building toward capital self-sufficiency until entitlements are eliminated and the annual savings reach the full $2 trillion annually in year 65.
That's still painful, of course, but it can be done — if we get a Capital Homestead Act . . . and control spending and eliminate all monetization of government deficits that would add to existing debt. First, all credit extended for speculation, consumption and government expenditures would have to come out of existing accumulations of savings. The market should set the interest rate. This would at one and the same time be a boon to pension plans, retirees who invested in government bonds, and others, and discourage speculation, unnecessary consumption and government spending as the true cost became evident.
The primary business of the commercial banking system and the Federal Reserve, however, would be to provide the private sector with sufficient money and credit to finance capital formation. This would mean reinstituting measures similar to Glass-Steagall to separate financial institutions by function, such as all forms of issue banking from all forms of deposit banking (e.g., commercial banking from investment banking, and both from insurance). There should also be specialization within both issue and deposit banking to avoid conflicts of interest and getting outside the institution's area of competence.
Reform of the "Income System." Most people today are trapped within the wage and welfare system as their sole source of income. Only a few are able to take advantage of the "ownership system," in which all or most of their income comes from capital ownership.
To institute a viable and sustainable economy that works for everyone, it is essential that every child, woman and man be able to participate in the economy to the best of their individual abilities and capacity. Most people would agree that anyone who is willing and able to contribute his or her labor should have the opportunity. That is not the problem. Lack of capital ownership is the problem. Most production today comes from capital, not labor — yet only those who currently own existing capital have, in general, both the opportunity and the means of owning future capital.
As capital replaces labor in the production process, the situation becomes critical. Because the rich and the State currently control the means of acquiring and possessing private property in capital, people remain dependent on wages and welfare for their subsistence. More and more people must own capital if the economy is to survive and thrive, but fewer and fewer people are able to.
Louis Kelso and Mortimer Adler advocated that the money creation powers of commercial banks backed up by the Federal Reserve be used to extend credit so that people who currently own little or no capital be able to purchase it in the form of new equity issues of corporations. The shares could be paid for using dividends paid on the shares themselves. Traditional collateral would be replaced with capital credit insurance and reinsurance, the premiums being paid with the risk premium charged on all private sector loans.
In this way people without savings could purchase capital and pay for the capital with the profits generated by the capital, just as the rich have done for centuries. The price of labor could fall (or, more likely, rise as prospective employers had to compete with ownership income to hire enough workers) to its true market value. Government manipulation of the currency to stimulate demand would become unnecessary as people met their own wants and needs through their own efforts. This would also decrease government expenditures for welfare, and shrink the federal and state budgets.
The wage and welfare system would be abolished (but obviously not wages and welfare!). Workers with ownership income would have the option of turning down a wage they did not consider adequate, thereby making wages rise naturally. If wages became too high, of course, human labor would be replaced with technology — but since the workers themselves would own the technology, it would increase income rather than eliminate it. As the tax base was rebuilt, those unfortunates unable to find work and whose investments were either failures or insufficient to meet their needs could receive welfare if private charity was unable to assist — and there would be a much larger funding pool.
These are some of the critical features of Capital Homesteading, which should be examined seriously by the current crop of political contenders. After all, few of us are able to dip into a suitcase full of gold coins to meet our needs as Pippi could.
#30#
Not too many of us have bottomless suitcases of gold — and even if we did, gold would cease to be worth much. (Sorry, Ron, there's nothing magical about a gold standard . . . or silver, either.) Gold isn't automatically money, any more than money has to be gold. Before the flood of silver that lowered the price of that metal throughout the world in the latter half of the 19th century, most of the world was on a silver standard, not gold. There simply wasn't — and isn't — enough gold to meet the needs of commerce.
With the spread of commercial and central banking, however, the amount of gold (or silver) became, to all intents and purposes, irrelevant. The only time the precious metals became important for monetary purposes was when a country insisted on pegging its currency to a specific weight of metal and permitted "convertibility" to give the public confidence in the currency.
The ability to convert a paper currency into gold or silver does not, however, mean that the paper currency is backed by gold or silver. Convertibility simply gives the public confidence that those pieces of paper are worth what it says on the face. What backs the currency are the bills and notes "accepted" by the issuing bank or State treasury. If the bills and notes represent the present value of existing or future marketable goods and services, the currency is asset-backed. If the bills and notes represent the present value of future tax collections by the State, the currency is debt-backed.
The problem that faces us today is, how do we shift from an ubiquitous and wildly fluctuating debt-backed currency, to a stable and uniform asset-backed currency?
Reform of the Banking System. As we noted yesterday, the Federal Reserve was established in part to provide the private sector — not government — with adequate liquidity to finance capital formation whenever existing accumulations of savings or other private resources failed or were inadequate. As Dr. Harold Moulton pointed out in The Formation of Capital (1935), using existing savings to finance new capital formation actually militates against economic growth as it decreases effective demand, making new capital investment less feasible. It is far better to monetize existing and future marketable goods and services by discounting qualified paper at commercial banks and rediscounting the paper at the Federal Reserve. This would ensure an adequate supply of loanable funds by tying the money supply directly to production, and back the currency with the present value of hard assets to which it would be bound by the institution of private property.
Current projections published recently in the Wall Street Journal reveal that by the end of the current fiscal year (09/30/12), the U.S. national debt will be 72-1/2% of GDP. This means that the money supply will consist mostly of instruments backed by government debt, and less than a third in the form of instruments backed by private sector hard assets. In 1913, government debt accounted for less than 20% of GDP. (We don't have time to do the actual calculation, and most sources today hide figures by giving past data in adjusted 1990 "international dollars," so we're using the statement found in Moulton's in Principles of Money and Banking, 1916, that private sector bills of exchange at that time accounted for 80% or more of all transactions.)
One of the goals of the Federal Reserve was to replace the National Bank Notes of 1863-1913 and the Treasury Notes of 1890 — all backed by government debt — with Federal Reserve Bank Notes backed by government debt purchased from the National Banks. The Federal Reserve Bank Notes would be replaced in turn with indistinguishable Federal Reserve Notes backed by the present value of private sector hard assets as private sector asset paper replaced government debt paper as the backing of the currency.
Ignoring the confusing distinction between the identical Federal Reserve Bank Notes and Federal Reserve Notes, a similar program could be carried out today simply by prohibiting the Federal Reserve from either discounting or rediscounting of primary or secondary government securities, or engaging in open market operations in secondary government securities. The only Federal Reserve transactions permitted with respect to government securities would be to sell — not buy — its holdings.
To restore confidence in the currency and the economy, it might be advisable to retire debt held outside the United States first, followed by government debt held by commercial banks, then the Federal Reserve. Any domestic holdings by institutions and individual investors could be left outstanding for a time, as these were purchased with existing savings, and were therefore not inflationary. This, of course, requires that all efforts be focused on increasing production of actual marketable goods and services, not pumping more inflationary government debt into the system.
According to the "National Debt Clock" (accessed today, 03/29/12), more than $5 trillion in U.S. debt is held outside the United States. Assuming all exports are purchased with U.S. dollars, that means that the U.S. has to export $5 trillion more than it imports to transfer the debt "in house." Note, however, that doesn't retire the debt. It simply shifts the holders of the debt from foreign companies and countries, to U.S. producers of exported goods.
Looking again at the National Debt Clock, we see that the total national debt is a little short of $16 trillion. (Half a trillion dollars or so is an immense amount of money, but it can get spent very quickly with little or no result, as we have seen, so we'll use $16 trillion.) We remember reading somewhere or other that no government can exact more than 20% of GDP as taxes without triggering a financial meltdown. That 20% is not the tax rate. It's the percentage of GDP that can be diverted into taxation, a different thing.
Assuming that's true, the United States is going to have to produce $80 trillion in marketable goods and services to generate the $16 trillion in tax revenues necessary to retire the debt — and that's on top of the $5 trillion trade surplus required to shift the foreign debt to domestic debt. That's $85 trillion of production that we're already on the hook for . . . plus whatever is needed to keep the government running in the meantime.
Assuming that government spending gets reduced and the total government budget is maintained at around $4 trillion for all government, local, state, and federal, annual GDP must increase — without inflationary distortion — to $25 trillion every year (a 66.67% rate of growth) in order to retire the debt at a rate of $1 trillion each year, or sixteen years. Reducing the debt at a rate of $500 billion a year gives us a target GDP of $22.5 trillion (50% growth rate) and a 32-year timetable. Debt reduction at the rate of $250 billion per year would give us a target GDP of $20.625 trillion (37.5% growth) and a 64-year timetable . . . but why go on? — and we're not even counting all the promises that have been made for Social Security and Medicare and (if the administration has its druthers) Obamacare.
At current rates of growth of around 1%, these targets for growth are more than unrealistic. They're in Fantasyland. If, however, we maintain the current rate of (non) growth, but reduce the entitlements that currently take up two-thirds of the federal budget by half, or approximately $1 trillion, we can apply those savings to debt reduction, and come up with the same 16- to 32-year timetable — you know a target of $1 trillion each year simply couldn't be met without a revolt, so cut it in half and double the time needed to pay down the debt.
Plus, you can't just cut people off. By phasing out entitlements instead of going cold turkey, however, replacing Social Security, Medicare and welfare gradually with Capital Homestead Accounts, we can get a reasonable 64-year timetable (call it 65, to tie in to a lifetime's capital accumulation under Capital Homesteading), reducing the debt by $250 billion each year, starting with zero debt reduction the first year and assuming that CHA income replaces entitlements dollar-for-dollar at an even rate as people start building toward capital self-sufficiency until entitlements are eliminated and the annual savings reach the full $2 trillion annually in year 65.
That's still painful, of course, but it can be done — if we get a Capital Homestead Act . . . and control spending and eliminate all monetization of government deficits that would add to existing debt. First, all credit extended for speculation, consumption and government expenditures would have to come out of existing accumulations of savings. The market should set the interest rate. This would at one and the same time be a boon to pension plans, retirees who invested in government bonds, and others, and discourage speculation, unnecessary consumption and government spending as the true cost became evident.
The primary business of the commercial banking system and the Federal Reserve, however, would be to provide the private sector with sufficient money and credit to finance capital formation. This would mean reinstituting measures similar to Glass-Steagall to separate financial institutions by function, such as all forms of issue banking from all forms of deposit banking (e.g., commercial banking from investment banking, and both from insurance). There should also be specialization within both issue and deposit banking to avoid conflicts of interest and getting outside the institution's area of competence.
Reform of the "Income System." Most people today are trapped within the wage and welfare system as their sole source of income. Only a few are able to take advantage of the "ownership system," in which all or most of their income comes from capital ownership.
To institute a viable and sustainable economy that works for everyone, it is essential that every child, woman and man be able to participate in the economy to the best of their individual abilities and capacity. Most people would agree that anyone who is willing and able to contribute his or her labor should have the opportunity. That is not the problem. Lack of capital ownership is the problem. Most production today comes from capital, not labor — yet only those who currently own existing capital have, in general, both the opportunity and the means of owning future capital.
As capital replaces labor in the production process, the situation becomes critical. Because the rich and the State currently control the means of acquiring and possessing private property in capital, people remain dependent on wages and welfare for their subsistence. More and more people must own capital if the economy is to survive and thrive, but fewer and fewer people are able to.
Louis Kelso and Mortimer Adler advocated that the money creation powers of commercial banks backed up by the Federal Reserve be used to extend credit so that people who currently own little or no capital be able to purchase it in the form of new equity issues of corporations. The shares could be paid for using dividends paid on the shares themselves. Traditional collateral would be replaced with capital credit insurance and reinsurance, the premiums being paid with the risk premium charged on all private sector loans.
In this way people without savings could purchase capital and pay for the capital with the profits generated by the capital, just as the rich have done for centuries. The price of labor could fall (or, more likely, rise as prospective employers had to compete with ownership income to hire enough workers) to its true market value. Government manipulation of the currency to stimulate demand would become unnecessary as people met their own wants and needs through their own efforts. This would also decrease government expenditures for welfare, and shrink the federal and state budgets.
The wage and welfare system would be abolished (but obviously not wages and welfare!). Workers with ownership income would have the option of turning down a wage they did not consider adequate, thereby making wages rise naturally. If wages became too high, of course, human labor would be replaced with technology — but since the workers themselves would own the technology, it would increase income rather than eliminate it. As the tax base was rebuilt, those unfortunates unable to find work and whose investments were either failures or insufficient to meet their needs could receive welfare if private charity was unable to assist — and there would be a much larger funding pool.
These are some of the critical features of Capital Homesteading, which should be examined seriously by the current crop of political contenders. After all, few of us are able to dip into a suitcase full of gold coins to meet our needs as Pippi could.
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Thursday, April 28, 2011
In the Blink of an Eye, Part IV: Word Games
This will (we hope) be the final posting in this series about repaying the national debt by changing one form of money into another. To recap, the idea was put forth to convert all interest-bearing government obligations of the United States, currently totaling somewhere in the rather exclusive neighborhood of $14.3 trillion, to non-interest-bearing "cash."
Also to recap, this would in no way reduce the national debt. It would simply change it from an obligation on which interest is paid, and thus presumably attractive to investors, to an obligation on which interest is not paid, and thus presumably unattractive to investors. The instruments would remain obligations, and the national debt would remain the same — that $14.3 trillion, after all, includes Federal Reserve Notes and government demand deposits at the Federal Reserve.
What seems to be behind the proposal is the fixed idea that government somehow "creates money," and that money "created" by the government does not have to be repaid or redeemed. As monetary theorist Gertrude Coogan claimed — erroneously — money is an unrepayable debt owed by the nation to itself.
On the contrary. "Money" is anything that can be used to settle a debt. That being the case, the issuer of money has to have some kind of property or other right in whatever backs the money so that the issuer can make good on the promise conveyed by the money. When private individuals and companies create money by drawing bills of exchange, they have to own the present value of whatever will be used to redeem the bill. When a government creates money by emitting bills of credit (the "constitutional version" of private sector bills of exchange), it must back the bills with its power to collect taxes and redeem the money in the future. Neither private individuals nor a government can draw bills of exchange or credit that are unredeemable, or there is no basis for accepting the money in exchange; the "faith and credit" of the issuer has been compromised, and the money is worthless.
The idea that a fiat currency is unredeemable by anything is called in logic a "fallacy of equivocation." True, a fiat currency is unredeemable in specie, that is, gold and silver. If issued by a private sector individual or business (including a bank), however, the original issuer of the money — the drawer of the bill of exchange — must deliver either the goods or services promised on the maturity date, or the value thereof in other goods or services, or other negotiable instruments, depending on the specific terms of the contract (bill), thereby redeeming the original promise. If a government emits a bill of credit, the government must eventually collect sufficient taxes to redeem the bill, or go bankrupt when people realize that the money is worthless and refuse to accept it as something that cannot be exchanged for what ultimately backs it. No one, whether private individual, business, or the State, has the power to make a promise he doesn't have to keep. Thus, we can see the weakness in the proposal as explained in the final posting in the discussion:
If we accept the explanations in this brief blog series, we can see that the Federal Reserve (according to Harold Moulton under the direct control of the federal government; the "independence" of the Federal Reserve is a transparent fiction, Moulton, Financial Organization and the Economic System
. Washington, DC: The Brookings Institution, 1938, 416-417) doesn't create money at all, whether by printing or "with key strokes on a computer." Nor does "a sovereign government . . . have that ability."
What happens when the Federal Reserve (or the federal government) manufactures some form of negotiable instrument backed by future tax collections instead of existing savings is to transfer wealth from the private sector to the State via the "hidden tax" of inflation. The only acceptable means to retire the national debt is not to repudiate it by transforming it into unredeemable fiat currency with no backing of any kind, but to rebuild the tax base, increase tax revenues, and pay down the debt with money created by the private sector. This can be done by drawing bills on the present value of existing and future marketable goods and services. These bills are discounted and rediscounted with individuals, enterprises, or banking institutions. They can then be rediscounted at the Federal Reserve (or purchased through open market operations) to provide an asset-backed currency with which to carry out day-to-day transactions, such as making consumer purchases and paying taxes.
Rebuilding the tax base and restoring a sound money supply, while critical, is not the focus of this series. Suffice to say that implementing the monetary and tax reforms embodied in Capital Homesteading would, we believe, fix the problems and put things back on a solid footing.
We do not think that repudiating the national debt (whatever the means or sleight-of-hand), printing more money, or "going back to gold" is the answer. The currency was never 100% gold and silver, anyway. Congressman George Tucker gave statistics in 1839 that estimated that gold and silver were less than 5% of the money supply at that time. In 1912, the year before the enactment of the Federal Reserve Act, U.S. GDP was $37.4 billion — and total estimated WORLD production of gold and silver from 1492 to 1912 was $29.1 billion. (Harold Moulton, Principles of Money and Banking
. Chicago, Illinois: University of Chicago Press, 1916, 74.)
Capital Homesteading is the only answer.
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Also to recap, this would in no way reduce the national debt. It would simply change it from an obligation on which interest is paid, and thus presumably attractive to investors, to an obligation on which interest is not paid, and thus presumably unattractive to investors. The instruments would remain obligations, and the national debt would remain the same — that $14.3 trillion, after all, includes Federal Reserve Notes and government demand deposits at the Federal Reserve.
What seems to be behind the proposal is the fixed idea that government somehow "creates money," and that money "created" by the government does not have to be repaid or redeemed. As monetary theorist Gertrude Coogan claimed — erroneously — money is an unrepayable debt owed by the nation to itself.
On the contrary. "Money" is anything that can be used to settle a debt. That being the case, the issuer of money has to have some kind of property or other right in whatever backs the money so that the issuer can make good on the promise conveyed by the money. When private individuals and companies create money by drawing bills of exchange, they have to own the present value of whatever will be used to redeem the bill. When a government creates money by emitting bills of credit (the "constitutional version" of private sector bills of exchange), it must back the bills with its power to collect taxes and redeem the money in the future. Neither private individuals nor a government can draw bills of exchange or credit that are unredeemable, or there is no basis for accepting the money in exchange; the "faith and credit" of the issuer has been compromised, and the money is worthless.
The idea that a fiat currency is unredeemable by anything is called in logic a "fallacy of equivocation." True, a fiat currency is unredeemable in specie, that is, gold and silver. If issued by a private sector individual or business (including a bank), however, the original issuer of the money — the drawer of the bill of exchange — must deliver either the goods or services promised on the maturity date, or the value thereof in other goods or services, or other negotiable instruments, depending on the specific terms of the contract (bill), thereby redeeming the original promise. If a government emits a bill of credit, the government must eventually collect sufficient taxes to redeem the bill, or go bankrupt when people realize that the money is worthless and refuse to accept it as something that cannot be exchanged for what ultimately backs it. No one, whether private individual, business, or the State, has the power to make a promise he doesn't have to keep. Thus, we can see the weakness in the proposal as explained in the final posting in the discussion:
When the Fed creates money by fiat, they call it "quantitative easing" or "money market operations" and the journalists call it "printing money." Printing money is the better metaphor, although hardly a precise description. "Quantitative easing" is obfuscation, pure and simple. What they are doing is creating money with key strokes on a computer. I am perfectly happy for a sovereign government to have that ability. Somebody has to do it. But since we know they can do it, why don't they do it on a scale sufficient to eliminate the national debt? They bailed out banks, insurance companies, hedge funds, government sponsored entities, such as Freddie Mac and Fannie Mae. Why don't they just bail out the United States Government?
If we accept the explanations in this brief blog series, we can see that the Federal Reserve (according to Harold Moulton under the direct control of the federal government; the "independence" of the Federal Reserve is a transparent fiction, Moulton, Financial Organization and the Economic System
. Washington, DC: The Brookings Institution, 1938, 416-417) doesn't create money at all, whether by printing or "with key strokes on a computer." Nor does "a sovereign government . . . have that ability."What happens when the Federal Reserve (or the federal government) manufactures some form of negotiable instrument backed by future tax collections instead of existing savings is to transfer wealth from the private sector to the State via the "hidden tax" of inflation. The only acceptable means to retire the national debt is not to repudiate it by transforming it into unredeemable fiat currency with no backing of any kind, but to rebuild the tax base, increase tax revenues, and pay down the debt with money created by the private sector. This can be done by drawing bills on the present value of existing and future marketable goods and services. These bills are discounted and rediscounted with individuals, enterprises, or banking institutions. They can then be rediscounted at the Federal Reserve (or purchased through open market operations) to provide an asset-backed currency with which to carry out day-to-day transactions, such as making consumer purchases and paying taxes.
Rebuilding the tax base and restoring a sound money supply, while critical, is not the focus of this series. Suffice to say that implementing the monetary and tax reforms embodied in Capital Homesteading would, we believe, fix the problems and put things back on a solid footing.
We do not think that repudiating the national debt (whatever the means or sleight-of-hand), printing more money, or "going back to gold" is the answer. The currency was never 100% gold and silver, anyway. Congressman George Tucker gave statistics in 1839 that estimated that gold and silver were less than 5% of the money supply at that time. In 1912, the year before the enactment of the Federal Reserve Act, U.S. GDP was $37.4 billion — and total estimated WORLD production of gold and silver from 1492 to 1912 was $29.1 billion. (Harold Moulton, Principles of Money and Banking
. Chicago, Illinois: University of Chicago Press, 1916, 74.)Capital Homesteading is the only answer.
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Wednesday, April 27, 2011
In the Blink of an Eye, Part III: Inflation
As we've seen so far in this series, a proposal to change government securities into cash — that is, currency — by simple fiat would, in theory, change nothing. There would be no elimination of the national debt, for regardless what form the obligation takes, the issuer still has to make good on it. Whether you call a piece of paper a "Treasury Note," or a "Federal Reserve Note" ultimately makes no difference. Recall in 1963 when all Silver Certificates were changed by fiat into Federal Reserve Notes. The notes still read "One Dollar (or Five) In Silver, Payable To The Bearer On Demand," but the promise had been negated, reduced to "legal tender for all debts public and private." The backing was changed from silver, to government debt.
The difference between what happened in 1963 and the proposal to transform all government securities from investments to currency should be obvious. Silver Certificates and Federal Reserve Notes were/are both forms of "current money," that is, "currency." They are, in fact, small denomination government securities — promissory notes — used to facilitate day-to-day transactions. As one of the participants in the original discussion that started this series responded,
Naturally, we could go on for pages (and we have) explaining the statements in the above response in greater detail, pointing out how we would have used a slightly different word because the one used might give the wrong impression, blah, blah, and showing how much more intelligent we are than any mere commentator, and so on. It's more important, however, to get at the truth and clarify possible misunderstandings — like the ones expressed in the response to the response:
There are a number of misconceptions in this rebuttal, some of which we've already covered. What we need to focus on right now, however, is the claim in the original proposal that repaying the debt by changing one form of money into another would not be inflationary. We disagree.
"Treasuries," while as fully "money" as any other type of negotiable instrument, whether issued by the State or a private person, are not usually current money, that is, they do not ordinarily circulate as currency in day-to-day transactions. They may very well be (and frequently are) used in large transactions, but not as a medium of exchange you typically carry around in your wallet. The holders in due course of government securities view the instruments more often as investments than as "money," per se, holding them for the interest income, not as media of exchange.
If, then, the interest provision was taken away, the character of the instruments as investments would be removed, and they would be construed as mere "cash," useful only as a store of value and medium of exchange. That being the case, all holders in due course who viewed the instruments as investments would immediately exchange them for interest-bearing securities or dividend-paying equity shares on the secondary market in order to maintain their incomes.
The effect of pouring an estimated $14.3 trillion (the size of the national debt according to the "National Debt Clock" as of this morning, 04/27/11) into the stock market can only be imagined. Prices of debt and equity instruments would skyrocket. Seeing greater speculative "returns" in the stock market than could be realized by engaging in productive activity, businesses and private individuals would put their money into the stock market instead of into the production of marketable goods and services, just as happened to a much lesser degree in 1929 — why work when all you have to do is borrow money to purchase secondary debt and equity instruments that are sure to go up in value? — a self-fulfilling prophecy . . . up to a point.
As production of marketable goods and services declined in response to the flight of capital from the productive sector to the secondary markets, prices to the consumer would begin to rise rapidly. As happened in Germany and Austria-Hungary following the First World War, hyperinflation would very likely kick in — hyperinflation being a condition in which the price level rises faster than money can be created. This would be due to the backing of the currency (the general wealth of the economy under Currency School assumptions) being transformed from the present value of existing marketable goods and services, to the speculative value of secondary debt and equity. The only difference would be that, following World War I, Germany's and Austria-Hungary's productive capacity was taken away in "reparations," while under this scenario the productive capacity of the United States would be starved for credit and simply unable to function — the difference between murder and suicide.
Ironically, the situation in Central Europe after the Great War is substantially no different from the situation today — or eighty years ago. This is a result of the shift in focus from productive activity (which, naturally, takes a relatively long time to realize adequate gains in return for producing marketable goods and services) to gambling in the stock market that embodies a "get rich quick" approach to "investment." (Cf. George Randolph Chester's "hero" of Get-Rich-Quick Wallingford: The Cheerful Account of the Rise and Fall of an American Business Buccaneer. New York: A. L. Burt Co., 1908.) The value of the currency falls, and real money income deteriorates rapidly. As Harold Moulton observed back in the 1930s,
That is, diversion of funds — existing accumulations of savings or new money backed only by the State's promise to pay — from either consumption or investment and into speculation, as provided the trigger for the Great Depression of the 1930s (so distinguished from the Great Depression of 1893-1898, and the current "recession"), causes a decline in real income. Paradoxically, the decline in real income accelerates as the rate of inflation increases.
What then happens is the baffling phenomenon of "stagflation." Stagflation is a weird combination of a decline in real income (effective deflation) due to lack of productive investment, at the same time the price level is rising in response to an increase in the volume of currency (inflation). This results from the conviction on the part of politicians that you can spend your way out of a deficit by creating massive amounts of effective demand in the form of currency ("cash") and pumping it into the economy, whether by "Quantitative Easing," or transforming money held as an investment into effective demand for secondary debt and equity.
#30#
The difference between what happened in 1963 and the proposal to transform all government securities from investments to currency should be obvious. Silver Certificates and Federal Reserve Notes were/are both forms of "current money," that is, "currency." They are, in fact, small denomination government securities — promissory notes — used to facilitate day-to-day transactions. As one of the participants in the original discussion that started this series responded,
Eliminating interest payments on the national debt would not eliminate the debt, though it should deter persons, corporations, and other governments from buying Treasuries and increasing the debt. This would be true especially now that the prospective downgrading of the U.S. government's creditworthiness would reduce the demand simply to park money in government notes and bonds.
Interest payments should be eliminated only on money created for investment in productive wealth by discounting and rediscounting, and, in fact, it would be good to permit money creation only for this purpose, because creating money for consumption or for speculation would be inflationary. One third of the wealth in America (as part of our GDP) consists of buying and selling money, mostly speculative, which has no real value at all. A two-tier system to differentiate productive wealth from non-productive (and therefore counter-productive wealth) would be a good compromise.
Naturally, we could go on for pages (and we have) explaining the statements in the above response in greater detail, pointing out how we would have used a slightly different word because the one used might give the wrong impression, blah, blah, and showing how much more intelligent we are than any mere commentator, and so on. It's more important, however, to get at the truth and clarify possible misunderstandings — like the ones expressed in the response to the response:
You misunderstood me. When the Federal Reserve and Treasury Department denote all outstanding treasury bills and notes as cash, but no longer bearing interest past the date of the conversion, all bond holders have been paid in full for their bonds in cash, with any additional payment necessary to bring the interest due current to the date of conversion. Thus the federal debt is eliminated — by fiat, yes, but that is how money is created. There is no default, because every bondholder is paid in full, 100 cents on the dollar, plus all accrued interest.
I am not suggesting that the Federal Reserve and Treasury Department could (or should) do this without explicit legislation. But I would much rather hear Congress debating such a bill than worrying about cutting necessary government services in a hopeless effort to pay off the national debt. We need to stop worrying about false economic issues and focus, as you suggest, on a more equitable economy, and one that operates within the limits of our natural environment in a way that is sustainable over the next thousand years.
There are a number of misconceptions in this rebuttal, some of which we've already covered. What we need to focus on right now, however, is the claim in the original proposal that repaying the debt by changing one form of money into another would not be inflationary. We disagree.
"Treasuries," while as fully "money" as any other type of negotiable instrument, whether issued by the State or a private person, are not usually current money, that is, they do not ordinarily circulate as currency in day-to-day transactions. They may very well be (and frequently are) used in large transactions, but not as a medium of exchange you typically carry around in your wallet. The holders in due course of government securities view the instruments more often as investments than as "money," per se, holding them for the interest income, not as media of exchange.
If, then, the interest provision was taken away, the character of the instruments as investments would be removed, and they would be construed as mere "cash," useful only as a store of value and medium of exchange. That being the case, all holders in due course who viewed the instruments as investments would immediately exchange them for interest-bearing securities or dividend-paying equity shares on the secondary market in order to maintain their incomes.
The effect of pouring an estimated $14.3 trillion (the size of the national debt according to the "National Debt Clock" as of this morning, 04/27/11) into the stock market can only be imagined. Prices of debt and equity instruments would skyrocket. Seeing greater speculative "returns" in the stock market than could be realized by engaging in productive activity, businesses and private individuals would put their money into the stock market instead of into the production of marketable goods and services, just as happened to a much lesser degree in 1929 — why work when all you have to do is borrow money to purchase secondary debt and equity instruments that are sure to go up in value? — a self-fulfilling prophecy . . . up to a point.
As production of marketable goods and services declined in response to the flight of capital from the productive sector to the secondary markets, prices to the consumer would begin to rise rapidly. As happened in Germany and Austria-Hungary following the First World War, hyperinflation would very likely kick in — hyperinflation being a condition in which the price level rises faster than money can be created. This would be due to the backing of the currency (the general wealth of the economy under Currency School assumptions) being transformed from the present value of existing marketable goods and services, to the speculative value of secondary debt and equity. The only difference would be that, following World War I, Germany's and Austria-Hungary's productive capacity was taken away in "reparations," while under this scenario the productive capacity of the United States would be starved for credit and simply unable to function — the difference between murder and suicide.
Ironically, the situation in Central Europe after the Great War is substantially no different from the situation today — or eighty years ago. This is a result of the shift in focus from productive activity (which, naturally, takes a relatively long time to realize adequate gains in return for producing marketable goods and services) to gambling in the stock market that embodies a "get rich quick" approach to "investment." (Cf. George Randolph Chester's "hero" of Get-Rich-Quick Wallingford: The Cheerful Account of the Rise and Fall of an American Business Buccaneer. New York: A. L. Burt Co., 1908.) The value of the currency falls, and real money income deteriorates rapidly. As Harold Moulton observed back in the 1930s,
The abundance of funds for investment in short-term liquid securities, and its scarcity for uses which involve loss of liquidity, point to a weakness in the financial structure of modern society; namely, the dissociation of the saving process from the productive utilization of funds. This difficulty is only accentuated, not created, by the depression. The unwillingness of many investors to part with their money except on the basis of a maximum assurance that they can get it back on demand, coupled with inability on the part of borrowers to make any productive use of purchasing power without immobilizing it, creates a perpetual problem. For, unless a connection is maintained between these savings and the growth of real capital, the saving process will exercise a perpetual downward pull on the money income of the community. (Harold G. Moulton, The Recovery Problem in the United States. Washington, DC: The Brookings Institution, 1936, 384.)
That is, diversion of funds — existing accumulations of savings or new money backed only by the State's promise to pay — from either consumption or investment and into speculation, as provided the trigger for the Great Depression of the 1930s (so distinguished from the Great Depression of 1893-1898, and the current "recession"), causes a decline in real income. Paradoxically, the decline in real income accelerates as the rate of inflation increases.
What then happens is the baffling phenomenon of "stagflation." Stagflation is a weird combination of a decline in real income (effective deflation) due to lack of productive investment, at the same time the price level is rising in response to an increase in the volume of currency (inflation). This results from the conviction on the part of politicians that you can spend your way out of a deficit by creating massive amounts of effective demand in the form of currency ("cash") and pumping it into the economy, whether by "Quantitative Easing," or transforming money held as an investment into effective demand for secondary debt and equity.
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Tuesday, April 26, 2011
In the Blink of an Eye, Part II: What Do You Mean by "Cash"?
Yesterday we started looking at a proposal to convert interest-bearing government obligations, to non-interest-bearing government obligations. As the question was phrased, it was whether it would be feasible to change government securities ("Treasuries") to "cash." Our quick answer was that it wouldn't make any difference. The obligation would remain the same. Whether the obligation is in the form of a Federal Reserve Note, a government demand deposit, or a T-Bill, the government still has to "make good" on the promise it conveyed when issuing the obligation.
As things are now, of course, the government has been satisfying (not exactly the right word) its old obligations with new obligations. Would it, then, make any difference whether the outward form of the obligation changed, or whether or not interest was paid? Let's look at those questions.
At one time (and depending on which country you were in), the "Ms" — the definition of money — went up to M7 and possibly beyond. The 1964 (6th) edition of Paul Samuelson's economics textbook mentions government securities as "near-money" (p. 275-277), a meaningless distinction outside the Currency School. This writer vaguely recalls a professor in college far too many years ago saying something about "M14," but the professor may have been joking — we were using a later edition of Samuelson's economics text, but the professor may have been Chicago School.
At present in Great Britain, "M5" represents the total money supply, which includes all debt instruments, such as government securities ("Treasuries"). In the United States, the Federal Reserve has been eliminating various Ms for decades. The latest round got rid of "M3." This restricted the definition of money to the point of absurdity in an effort to impose more State control on the financial system to attain desired results, such as low inflation and full employment. (This may be analogous to the way the Bureau of Labor Statistics keeps changing the definition of "unemployment" so that the level of unemployment doesn't scare people too badly, or how the definition of inflation is tailored to exclude food and oil prices.)
The fact that government securities are already money was noted in the original question . . . which we haven't posted yet, so let's look at the original proposal, numbering the paragraphs for convenience:
Let's deal with the "easy" questions first. We agree that government securities — and all private securities that take the general form of mortgages and bills of exchange (both real and fictitious) — are "money" as that term is understood in the Banking School of finance. The Federal Reserve no longer uses M3, for the reasons above, but that's just "word games" being played to try and fool people into thinking an unworkable system can be made to work, even when based on bad or false assumptions.
It's the issue of interest that interests us here. First, there is no effective interest rate on government securities held by the Federal Reserve. After subtracting administrative fees to offset costs of running the system, all Federal Reserve profits are turned over to the federal government . . . that paid the interest in the first place, not to the member banks that are the ostensible "owners" of the Federal Reserve, and that receive no benefit, and cannot even vote their shares. (The shares are actually an interest-bearing membership deposit, and do not represent real ownership.)
As for converting interest-bearing government obligations held by members of the public (including foreign countries and individuals) into non-interest-bearing obligations, that might violate the Fifth Amendment: "No person shall be . . . deprived of life, liberty, or property, without due process of law; nor shall private property be taken for public use, without just compensation."
It might be argued that the proposal is simply to convert the face value of an interest-bearing security into a non-interest-bearing obligation, but consider the possibility that you would thereby deprive the holder of that security of the anticipated future stream of interest payments, in expectation of which the security was purchased in the first place, often by a retiree who needs that income to meet living expenses, or a pension plan or mutual fund with the same goal. You would, in short, be depriving someone of the present value of the future stream of income, and not compensating him or her for it. The holder in due course of any obligation is entitled to both the principal and the interest, and the proposal deprives the holder in due course of the interest, to say nothing of making it more difficult to locate an affordable alternative with the same degree of security as a government bond.
Inflation is another issue, but we'll look at that tomorrow.
#30#
As things are now, of course, the government has been satisfying (not exactly the right word) its old obligations with new obligations. Would it, then, make any difference whether the outward form of the obligation changed, or whether or not interest was paid? Let's look at those questions.
At one time (and depending on which country you were in), the "Ms" — the definition of money — went up to M7 and possibly beyond. The 1964 (6th) edition of Paul Samuelson's economics textbook mentions government securities as "near-money" (p. 275-277), a meaningless distinction outside the Currency School. This writer vaguely recalls a professor in college far too many years ago saying something about "M14," but the professor may have been joking — we were using a later edition of Samuelson's economics text, but the professor may have been Chicago School.
At present in Great Britain, "M5" represents the total money supply, which includes all debt instruments, such as government securities ("Treasuries"). In the United States, the Federal Reserve has been eliminating various Ms for decades. The latest round got rid of "M3." This restricted the definition of money to the point of absurdity in an effort to impose more State control on the financial system to attain desired results, such as low inflation and full employment. (This may be analogous to the way the Bureau of Labor Statistics keeps changing the definition of "unemployment" so that the level of unemployment doesn't scare people too badly, or how the definition of inflation is tailored to exclude food and oil prices.)
The fact that government securities are already money was noted in the original question . . . which we haven't posted yet, so let's look at the original proposal, numbering the paragraphs for convenience:
1. Why don't we pay off the national debt by "monetizing the debt," that is, by declaring that all Treasury bonds and bills are now non-interest-bearing cash accounts? This would stop the drain on national resources of on-going interest payments, and relieve concerns that the debt will destroy our economic vitality, or impose an undue burden on our grandchildren.
2. Some would object that it would be grossly inflationary, because it creates such a huge amount of new money. But, in fact, the Treasury bills and bonds are already "money" (M3) for all practical purposes, so it's just converting interest-bearing money to non-interest bearing money. Those who wish to may use that cash to start buying other interest bearing bonds, probably from Blue Chip corporations and states and municipalities, thus driving down the interest that state and municipalities and corporations have to pay for such bonds, because of increased demand for them.
3. Paying off the national debt does not produce more natural resources. But it may result in a more equitable distribution of claims against products and services, and mobilize national resources to provide more goods and services, stimulating job-creation.
4. It is a feature of sovereign governments that they can create money. Since our Federal Reserve System operates to allow most creation of money by private banks, we need to restructure the Reserve System to make it a truly national bank. Private banks create money to advantage bankers. The money that a government-owned central bank creates can and should benefit all Americans, and not just the rich.
Let's deal with the "easy" questions first. We agree that government securities — and all private securities that take the general form of mortgages and bills of exchange (both real and fictitious) — are "money" as that term is understood in the Banking School of finance. The Federal Reserve no longer uses M3, for the reasons above, but that's just "word games" being played to try and fool people into thinking an unworkable system can be made to work, even when based on bad or false assumptions.
It's the issue of interest that interests us here. First, there is no effective interest rate on government securities held by the Federal Reserve. After subtracting administrative fees to offset costs of running the system, all Federal Reserve profits are turned over to the federal government . . . that paid the interest in the first place, not to the member banks that are the ostensible "owners" of the Federal Reserve, and that receive no benefit, and cannot even vote their shares. (The shares are actually an interest-bearing membership deposit, and do not represent real ownership.)
As for converting interest-bearing government obligations held by members of the public (including foreign countries and individuals) into non-interest-bearing obligations, that might violate the Fifth Amendment: "No person shall be . . . deprived of life, liberty, or property, without due process of law; nor shall private property be taken for public use, without just compensation."
It might be argued that the proposal is simply to convert the face value of an interest-bearing security into a non-interest-bearing obligation, but consider the possibility that you would thereby deprive the holder of that security of the anticipated future stream of interest payments, in expectation of which the security was purchased in the first place, often by a retiree who needs that income to meet living expenses, or a pension plan or mutual fund with the same goal. You would, in short, be depriving someone of the present value of the future stream of income, and not compensating him or her for it. The holder in due course of any obligation is entitled to both the principal and the interest, and the proposal deprives the holder in due course of the interest, to say nothing of making it more difficult to locate an affordable alternative with the same degree of security as a government bond.
Inflation is another issue, but we'll look at that tomorrow.
#30#
Monday, April 25, 2011
In the Blink of an Eye, Part I: The "Brief" Answer
As you know if you've been reading this blog, we've been a little taken up with extra and curricular activities. These include the annual Rally at the Fed, the CESJ annual meeting, the CESJ annual celebration, preparation of a paper for possible submission to a law journal, "Income Tax Day" burdens, County and Commonwealth tax filings, Easter/Spring musical preparation (belonging to two groups, one connected with a church, tends to have its downside around Christmas and Easter, although the incidence of goodies during rehearsal break increases — kudos to Lynnette for the Easter cupcakes with jelly beans and green coconut "sprinkles," BTW), and a few other things, like Spring Cleaning.
That being the case, we weren't paying too much attention to our e-mails. We tended to rush through them just to get them out of the way. We almost missed the thread in the Kelso Binary Economics Group about retiring the (U.S.) national debt in the twinkling of an eye. (We headed this series of postings "In the Blink of an Eye" purely as a matter of personal preference, not out of any dislike of Hostess confections or anything else.)
Thus we were pleasantly surprised early this morning opening our neglected e-mails to discover that we could escape from doing too much work while resting up from the rigors of the recent holiday weekend. (If you don't think it's rigorous being in the choir and having to stand for hours at a time when you can't find your special concert shoes, and listening to what amounts to substantially the same sermon four times in a row . . . try it sometime.)
In short, we received the following query from a long-time Just Third Way supporter. Names are deleted to protect the guilty and to make the series generic; also we did some editing and corrected some spelling that we don't think changes the substance any:
Have we mentioned how much we love it when others do our work for us? Anyway, we'll give the brief answer today, and follow it up the rest of this week (and possibly beyond) to give the explanation(s) behind the quickie answer. Also, as we've noted a couple of times in the News from the Network (posted each Friday on this blog, free plug), we've been working on a paper covering the subject of money, credit, banking and finance from the perspective of binary economics in more depth, and the first draft is finished. Right now we're adding footnotes and cites, and refining the language, but we hope to have it ready "soon" (whatever that means), largely because we're trying to schedule a meeting with a potential publisher for next week . . . or whenever we can get it.
Now to the "quick answer."
From within the "Banking School" principles of the Just Third Way, the proposed conversion of existing government securities into "cash" is not a viable option.
[N.B., 19th and 20th century writers frequently used the terms "Banking School" and "Banking Principle(s)" interchangeably. That is, when they weren't confusing the elasticity of currency that occurs "naturally" with the application of Banking School principles, with the elasticity of currency that results from State manipulation of the currency under some applications of Currency School principles. (We'll discuss the "convertibility" issue and its relation to the two schools of finance, that is, a paper currency redeemable in gold and silver, some other day.)]
Here's why (briefly):
From a Just Third Way perspective, the proposal does nothing to meet government obligations and retire outstanding debt. It would simply transform one outward appearance of money into another by modifying the definition without changing the thing's substantial nature.
This is because all money is, in a sense, debt — just as all debt is money, as Henry Dunning Macleod explained — "money" and "credit" being simply two different forms of the same thing. A debt is a contract that requires the delivery of something of value in order to be satisfied, either on demand, or on the occurrence of some specified future event, such as a maturity date.
To oversimplify a little, the key to a sound currency is whether the "money debt" is backed by the present value of marketable goods and services in which the issuer of the money has a property stake (ownership), or whether the debt is backed by a promise to pay out of future tax revenues.
Under the theory of government held by the Founding Fathers of the United States, the government does not have a property stake in the tax base. That is, the State does not own the general wealth of the economy, usually cited as the backing of the currency under the present system. In the U.S. system, taxes are construed as a grant from the citizens, not an exercise of property by the State.
Thus, in effect, under the present system, the federal government is making promises for other persons (yes, the government is a "person") to keep. The "other persons" are the future generations who are going to get stuck paying the bill for today's deficit spending, assuming we avoid national bankruptcy.
Can we, then, bail out the U.S. government by converting U.S. government securities ("Treasuries") to cash and thereby eliminate the national debt?
No.
Why?
Assuming that by "cash" we mean "M1" and "M2," i.e., the Federal Reserve's (current) definition of "money" — coin, banknotes, demand deposits (checking accounts), and selected time deposits (savings accounts) — adding "Treasuries" to the Federal Reserve definition of "money" would do absolutely nothing. All that would be accomplished is a change in definition, a verbal sleight-of-hand. The reality — a gigantic pile of debt owed by the federal government to holders of its instruments — would remain unchanged.
This is because there is no legal difference as money between the token coinage, Federal Reserve Notes (direct obligations of the federal government, not the Federal Reserve, thanks to William Jennings Bryan . . . long story), or any other negotiable instruments issued by the government. They are already "money," and can all be used to settle debts by holders in due course until redemption — assuming that people still have faith in the "faith and credit" of the U.S. government, and will accept the instruments in the expectation that the government will (eventually) make good on them.
That isn't much of an answer, so we'll explain ourselves starting tomorrow. Remember: even at over 1,000 words, that's the short answer.
#30#
That being the case, we weren't paying too much attention to our e-mails. We tended to rush through them just to get them out of the way. We almost missed the thread in the Kelso Binary Economics Group about retiring the (U.S.) national debt in the twinkling of an eye. (We headed this series of postings "In the Blink of an Eye" purely as a matter of personal preference, not out of any dislike of Hostess confections or anything else.)
Thus we were pleasantly surprised early this morning opening our neglected e-mails to discover that we could escape from doing too much work while resting up from the rigors of the recent holiday weekend. (If you don't think it's rigorous being in the choir and having to stand for hours at a time when you can't find your special concert shoes, and listening to what amounts to substantially the same sermon four times in a row . . . try it sometime.)
In short, we received the following query from a long-time Just Third Way supporter. Names are deleted to protect the guilty and to make the series generic; also we did some editing and corrected some spelling that we don't think changes the substance any:
We need some expertise here. If we can bail out insurance companies and banks, one argument is that we can bail out the U.S. government by converting U.S. government securities ("Treasuries") to cash and thereby eliminate the national debt. This gimmick would be better than merely declaring national bankruptcy as Brazil and Argentine did in order to start their economic miracles. Our present policies are self-destructive, so almost anything would be better than repeating what we do over and over again without any effect, which is a behavior that is normal only in insane asylums.
Although this is now all theoretical, it might offer an opportunity to restrict all money creation to productive investment through rediscounting eligible commercial paper, as envisaged in Section 13 of the Federal Reserve Act of 1913 but rarely if ever used, or at least to create a two-tier interest rate whereby money available for consumption would carry high interest rates in order to steer money to productive uses. This could double our gross national product and through broadened capital ownership triple the money available for consumption.
This sounds like something that the Tea Party would love and could thereby introduce Capital Homesteading via the backdoor as an add-on. In my comments below as a pragmatist I've suggested some possible boomerang effects, but how could either the liberals or the conservatives object on principle?
Have we mentioned how much we love it when others do our work for us? Anyway, we'll give the brief answer today, and follow it up the rest of this week (and possibly beyond) to give the explanation(s) behind the quickie answer. Also, as we've noted a couple of times in the News from the Network (posted each Friday on this blog, free plug), we've been working on a paper covering the subject of money, credit, banking and finance from the perspective of binary economics in more depth, and the first draft is finished. Right now we're adding footnotes and cites, and refining the language, but we hope to have it ready "soon" (whatever that means), largely because we're trying to schedule a meeting with a potential publisher for next week . . . or whenever we can get it.
Now to the "quick answer."
From within the "Banking School" principles of the Just Third Way, the proposed conversion of existing government securities into "cash" is not a viable option.
[N.B., 19th and 20th century writers frequently used the terms "Banking School" and "Banking Principle(s)" interchangeably. That is, when they weren't confusing the elasticity of currency that occurs "naturally" with the application of Banking School principles, with the elasticity of currency that results from State manipulation of the currency under some applications of Currency School principles. (We'll discuss the "convertibility" issue and its relation to the two schools of finance, that is, a paper currency redeemable in gold and silver, some other day.)]
Here's why (briefly):
From a Just Third Way perspective, the proposal does nothing to meet government obligations and retire outstanding debt. It would simply transform one outward appearance of money into another by modifying the definition without changing the thing's substantial nature.
This is because all money is, in a sense, debt — just as all debt is money, as Henry Dunning Macleod explained — "money" and "credit" being simply two different forms of the same thing. A debt is a contract that requires the delivery of something of value in order to be satisfied, either on demand, or on the occurrence of some specified future event, such as a maturity date.
To oversimplify a little, the key to a sound currency is whether the "money debt" is backed by the present value of marketable goods and services in which the issuer of the money has a property stake (ownership), or whether the debt is backed by a promise to pay out of future tax revenues.
Under the theory of government held by the Founding Fathers of the United States, the government does not have a property stake in the tax base. That is, the State does not own the general wealth of the economy, usually cited as the backing of the currency under the present system. In the U.S. system, taxes are construed as a grant from the citizens, not an exercise of property by the State.
Thus, in effect, under the present system, the federal government is making promises for other persons (yes, the government is a "person") to keep. The "other persons" are the future generations who are going to get stuck paying the bill for today's deficit spending, assuming we avoid national bankruptcy.
Can we, then, bail out the U.S. government by converting U.S. government securities ("Treasuries") to cash and thereby eliminate the national debt?
No.
Why?
Assuming that by "cash" we mean "M1" and "M2," i.e., the Federal Reserve's (current) definition of "money" — coin, banknotes, demand deposits (checking accounts), and selected time deposits (savings accounts) — adding "Treasuries" to the Federal Reserve definition of "money" would do absolutely nothing. All that would be accomplished is a change in definition, a verbal sleight-of-hand. The reality — a gigantic pile of debt owed by the federal government to holders of its instruments — would remain unchanged.
This is because there is no legal difference as money between the token coinage, Federal Reserve Notes (direct obligations of the federal government, not the Federal Reserve, thanks to William Jennings Bryan . . . long story), or any other negotiable instruments issued by the government. They are already "money," and can all be used to settle debts by holders in due course until redemption — assuming that people still have faith in the "faith and credit" of the U.S. government, and will accept the instruments in the expectation that the government will (eventually) make good on them.
That isn't much of an answer, so we'll explain ourselves starting tomorrow. Remember: even at over 1,000 words, that's the short answer.
#30#
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