Own the Fed, Part XVIII: The Great Recession

A number of economic downturns have been termed "the Great Recession." Usually this appears to be a derisive label assigned in view of the authorities' refusal to use the Dreaded D Word — "Depression." As the old joke has it, however, a recession is when you lose your job, a depression when I lose mine. The terminology used is pretty much a matter of personal preference.

Unfortunately, the current economic situation is no joking matter. Neither is it something that came from out of nowhere. On the contrary, the global financial crisis that the Federal Reserve claims began in the United States in August of 2007, and began to avalanche with a series of financial crises throughout the world, is the culmination of a series of events and the decisions made in reaction to those events by those in power for a full century.

Nor were these decisions made in isolation, but in obvious conformity to a specific orientation toward the role of the State and the place of the human person in society. This orientation is reflected most immediately in the understanding (or lack thereof) of the institutions of money, credit, and banking. Had the dignity of the human person instead of the demands of the State been at the center, the decisions would necessarily have been along completely different lines, and the outcome would have been substantially different.

Stated most simply, the understanding of money and credit (and, consequently, banking) that drove the decisions was responsible for their direction and orientation. Briefly, the common — and incorrect — understanding of money is that production is a derivative of money. That is, money must exist before there can be any production of marketable goods and services. This sets up an inherent contradiction, for in order to have an accumulation of money with which to finance capital formation so that marketable goods and services can be produced, it is necessary first to cut consumption of marketable goods and services. In other words, the common assumption is that you must first produce marketable goods and services before you can produce marketable goods and services.

Obviously, this is nonsense. Reality is exactly the opposite. Production is not a derivative of money. Instead, money is a derivative of production — the present value of existing or future marketable goods and services, to be exact. As Jean-Baptiste Say explained,

We do not in reality buy the objects we consume, with the money or circulating coin which we pay for them. We must in the first place have bought this money itself by the sale of productions of our own. To the proprietor of the mines whence this money is obtained, it is a production with which he purchases such commodities as he may have occasion for: to all those into whose hands this money afterwards passes, it is only the price of the productions which they have themselves created by means of their lands, capital, or industry. In selling these, they exchange first their productions for money; and they afterwards exchange this money for objects of consumption. It is then in strict reality with their productions that they make their purchases; it is impossible for them to buy any articles whatever to a greater amount than that which they have produced either by themselves, or by means of their capitals and lands. (Jean-Baptiste Say, Letters to Mr. Malthus on Several Subjects of Political Economy and on the Cause of the Stagnation of Commerce. London: Sherwood, Neely & Jones, 1821, 2.)

The question then becomes understanding how we — and the Federal Reserve — ever got away from this common sense view of money and credit. The answer appears to lie in the attitude that developed at an accelerating rate in the 20th century, that the State is not only the guardian of the common good, but the provider of the common good as well as all individual goods.

There are, in general, two views of the role of the State. At one end of the spectrum is anarchy, in which there is effectively no State. Every human being is a law unto him- or herself, freely deciding which (if any) laws to obey as circumstances or personal preferences dictate. At the other end of the spectrum is collectivism, in which the individual is completely subsumed in an undifferentiated mass. In the former, there is no recognition of the human person as being in any way inherently social. In the latter, there is no recognition of human beings as "natural persons," that is, individuals with inherent or inalienable rights.

There is a third view of the role of the State. This is a position based on justice, a "Just Third Way." In germ, this was the understanding of Aristotle, best expressed (although not best understood by many people today) in the short observation, "Man is by nature a political animal." That is, human beings are both individuals with inherent rights, and social creatures who naturally come together to realize their fullest development as human beings within a social setting. Aristotle called this social setting the "polis," the city-state, hence the description of humanity as political animals.

Individuality implies inherent natural rights. On the other hand, our social nature implies the State. The former recognizes and protects our individual identity from unwarranted intrusion by other individuals, groups, or the State itself. The latter recognizes and protects the social order, within which we as moral beings acquire and develop virtue and so become more fully human.

What has this got to do with money and credit, and the role of the Federal Reserve? Everything. If we believe that responsibility for human development rests primarily with the human person, individually or in free association with others, then we necessarily hold that the State has a very limited role in both economic and (surprisingly) political life. The primary responsibility for both individual and general welfare rests with the human person. For individual welfare, the individual (as we might expect) is chiefly responsible, while for general welfare, the primary responsibility rests with the individual in free association with others.

The State's role in the Just Third Way is to safeguard the social order. That is, the State's job is to ensure that the system operates as it is structured in accordance with certain basic principles, of which justice is the most important. Except as a last resort in response to an emergency, and as a recognized expedient, the State is not to provide for individual welfare, whether of discrete individuals or individuals assembled in groups. The State's legitimate role must necessarily be limited to ensuring a "level playing field," policing abuses, and maintaining order.

If, however, we believe that responsibility for human development rests primarily with the State, a human creation (albeit in response to the social nature hard wired into us as human beings), then we necessarily hold that the State has the responsibility not only to protect and maintain the common good — the general welfare — but to structure the common good, and to ensure that all individual goods are provided to everyone. This orientation is loosely termed "equality of results," although true equality is often the last thing achieved.

Because equality of results (as opposed to equality of opportunity) is contrary to human nature, it requires an ever-increasing degree of State control and intrusion into the daily lives of the citizens to establish and maintain any degree of false equality. As Moulton commented in the 1930s in the wake of the virtual takeover of the financial systems by the State via the New Deal,

During the last twenty years central banks everywhere have become increasingly linked with government fiscal operations. In nearly every country there has been a decline in the proportion of credit granted to trade and industry as compared with that granted to the state. While the charters of most central banks contain restrictions with respect to state loans, such limitations have been impossible of enforcement in the face of the financial exigencies of recent times. Commercial banks are not only very large holders of government issues, but in the majority of cases they are under the practical necessity of underwriting huge current deficits. . . .

. . . with the coming of the world depression and the need of funds to support tottering banking institutions and relieve unemployment, control of government over the central banks once more increased everywhere. The extent of government control over the administration of banks varies considerably. In the case of state owned banks it is complete; in the case of the privately owned central banks the government commonly has representation on the Board. In most cases the presiding officer of the bank is appointed by, and is subject to removal by, the government. Thus the trend noted in the United States in preceding chapters is part of a universal phenomenon. (Financial Organization and the Economic System, op. cit., 429-430.)

What happened in the "Age of Deregulation" of the 1980s and 90s was that the financial services industry put immense pressure on the State to remove systemic, internal controls in the name of economic freedom. They especially targeted the Banking Act of 1933 — "Glass-Steagall" — and the Bank Holding Company Act of 1956 for repeal. The effective internal control measures of Glass-Steagall and the Bank Holding Company Act were replaced by ineffective "external" controls in the form of existing laws prohibiting conflict of interest — laws that were intended to function as backups to internal, systemic controls, not to provide the control. Conflict of interest is virtually impossible to avoid when it is built into the system by combining such incompatible elements as commercial banking, investment banking, and insurance.

A conflict of interest under the separation imposed by Glass-Stegall was painfully obvious, simply because it necessarily involved two or more discrete entities, and collusion between them was clear and apparent. After the full repeal of Glass-Steagall, whether or not a conflict of interest occurred became a matter of a judge's opinion. This became a very gray area, and not obvious at all. Whether a conflict of interest was deemed to have occurred sometimes depended on whether a financial services company was deemed "too big to fail," and thus immune from prosecution, or whether other political motives entered into the decision. The effect was to enable the financial services industry to enter into combinations that rivaled the power of the financial empire over which J. P. Morgan ruled in the early 20th century — and which caused the Panic of 1907.

Ironically, some very bad regulations were retained. These included such requirements as "equal opportunity" lending that lured financial institutions into lowering standards in order to comply with political directives not to discriminate in, e.g., housing loans or other consumer credit. This encouraged bad uses of credit and speculation, in preference to good uses of credit and productive investment.

Ultimately, expecting the State to assume responsibility for ensuring that no conflicts of interest occurred means that something is wrong only if you get caught — and sometimes not even then, especially if you are "too big to fail." There is also the far more fundamental problem that expecting the State to do everything, rather than assist an organized citizenry in setting up and maintaining a self-regulating system, leads to functional overload of a very powerful (and thus very dangerous) tool. The State, despite what its worshipers claim or believe, cannot do everything. Paradoxically, expecting the State to do everything leads to its being unable to do anything either effectively, well, or (eventually) at all.

This, then, was the setting for the global financial crisis. Depending on your source(s), the current recession began in the United States either in August of 2007, or a few months later, in December of the same year. By September of 2008 the crisis began to worsen at an accelerating rate, affecting most of the industrialized countries of the world. Economic activity slowed tremendously, assisted in no small measure by a number of factors reminiscent of those that preceded the Crash of 1929.

Significantly, the global economic environment was — and remains — characterized by serious imbalances. The most obvious of these imbalances is the growing "wealth gap" not just between countries believed to be rich and those considered poor, but most dramatically between ordinary citizens in presumably wealthy countries and the "super rich." The paradox of an allegedly wealthy country in which most of the citizens qualify as poor relative to the immense accumulations of the top tenth of one percent has ceased to be regarded as anything unusual.

Under the influence of Keynesian economics, the wealth gap is regarded as necessary, even beneficial by those in power. The alarming incidence of riches in the midst of poverty has ceased to alarm; disparities in wealth, far from causing politicians and policymakers grave concern, is viewed as a desirable state, and the wealthy an endangered species that must be protected to encourage economic growth.

The problem with regarding any class of persons as special and insulating them from their own folly is a clear signal of a badly structured social order. It encourages, even subsidizes bad and counterproductive behavior on the part of individuals and groups so protected. The welfare system and affirmative action, while there are some exceptions, have — as Alexis de Tocqueville predicted in his Memoir on Pauperism (Memoir on Pauperism: Does Public Charity Produce an Idle and Dependent Class of Society? New York: Cosimo Classics, 2006) — by and large destroyed the culture and sense of family and community of African Americans. (cf. Star Parker, Uncle Sam's Plantation: How Big Government Enslaves America's Poor and What We Can Do About It. Nashville, Tennessee: Thomas Nelson Publishers, 2005.)

Obviously, dependency on the State is not just for the poor any more. Treating wealthy stock market speculators as a special class has had a similar effect. Repealing Glass-Steagall and similar legislation, and shielding the gamblers from the consequences of their own irresponsible behavior encouraged speculation and discouraged productive activity. The returns on successful speculation are always immensely higher than what can be realized by producing marketable goods and services.

When the gambler is assured of winning whether the speculation makes or loses money, gasoline is poured on the fire fueling the mania. The government bailout of the savings and loan industry in the 1980s and 90s was tantamount to a virtual guarantee that the State would ensure that the financial industry would sustain no unacceptable losses. The sheer size of the new combinations and the degree to which the financial and economic well-being seemed dependent on the existing accumulations of savings controlled by the financial services industry made certain that the new financial monopolies would be considered too big to fail.

The blindness of both government officials and academic economists to the fact that existing accumulations of savings are not essential for financing capital formation shackled the global economy firmly to what Kelso and Adler called "the slavery of savings." The inevitable consequence of dependency on savings is that owners of savings must be protected at all costs — even if the result is to destroy the value of those savings, and even if the savings are not used for productive purposes and reinvestment, but for gambling and speculation. Boys will be boys. What are you going to do?

Consequently, the financial services industry in what might be described as virtual collusion with government agencies — the former motivated by greed, the latter by political expedience — promoted what can only be described as very bad, almost colossally stupid expansion of credit. Money was created in massive amounts through what has been described as "reckless and unsustainable lending practices." This was made infinitely worse by increasing State interference in the financial system, promotion of greater and greater amounts of consumer credit (and thus unserviceable consumer debt), and what proved to be a very dangerous development, the securitization of residential real estate mortgages, especially in the United States.

Through Fannie Mae and Freddie Mac the federal government had made home ownership a seemingly viable goal for the majority of Americans, especially those in the lower income brackets. Home ownership was touted not only as the best means of securing a roof over one's head, but as an important feature of retirement planning and thus an "investment." From regarding one's ownership of a home as a way of saving for retirement (which begs the question as to where one is supposed to live once the home is sold), to viewing it as a means of generating current income through speculation is a very short leap.

In the current financial environment that has confused speculation with true investment for generations, such a shift was inevitable. People who clearly could not afford what they were buying even at the true value were lured into purchasing homes far beyond their means. Making the situation worse was that this was in a market in which massive money creation was inflating prices far beyond the real value of the houses.

So-called "sub-prime mortgages," the chief means of financing purchases by unqualified buyers, had hidden, even unexpected triggers built into them. If the real estate market continued to rise without limit (much as speculators had been assured the stock market would continue to go up before October 1929), buyers could presumably refinance based on the increased value of the house. If they could not refinance, or preferred to make even more money, they could sell and pocket a substantial profit, which could then be used to leverage the purchase of another, even more expensive house.

To confuse matters even more, the sub-prime mortgages were bundled together with prime mortgages in a process called "securitization." This made the risks associated with such mortgage-backed securities extremely difficult to assess. Influenced by the financial euphoria, the U.S. mortgage-backed securities were marketed throughout the world. At the same time, massive money creation was also fueling global speculation in real estate and equity issues, driving stock markets to record highs. (The Florida land bubble that burst in 1925 as well as the 1929 Crash come forcibly to mind.) At the same time, in a series of events recalling the stagflation of the 1970s, oil and food prices began increasing rapidly.

The bubble was unsustainable, and it began to deflate rapidly in mid-2007. Losses on speculation in sub-prime mortgages revealed an entire superstructure of risky loans and grossly inflated asset values. When the venerable investment banking firm of Lehman Brothers filed for Chapter 11 reorganization on September 15, 2008, the inter-bank loan market went into a panic. Housing prices and values of equity shares on the secondary market plunged. Other financial services companies in the U.S. and Europe were hit with enormous losses as a result of speculative lending and money creation.

Many of these firms were faced with bankruptcy, only being rescued by massive State bailouts, the effect of which was to throw good money after bad. In September and October of 2008, for example, the Federal Reserve created money to purchase distressed assets, more than doubling the total factors supplying reserve funds, from $936 billion in August of 2008 to more than $1.9 trillion by the end of October of that year. (http://federalreserve.gov/releases/h41/) The massive infusion of cash offset the deflation that would otherwise have occurred as securities and other assets settled to their proper values. This resulted in a type of "hidden inflation" by maintaining an artificially high price level for speculative assets.

With the emphasis on rescuing the speculators and gamblers, productive activity and new capital investment suffered. Just as in 1929, there was a sharp drop in international trade, commodity prices fell, and unemployment rose rapidly. Although the official line of the government has been that commercial banks are refusing to lend, the fact of the matter is that borrowers who seek to finance new capital formation are "refusing" to qualify. The productive sector does not enjoy the protections afforded to speculators and gamblers, and (just as in the Great Depression) lacks access to adequate or secure collateral. Government bailouts and guarantees have been reserved for the unproductive, not for the productive.

Although the end of the recession has been announced several times since mid-2009, this appears to be more wishful thinking on the part of economists, policymakers, and politicians than anything else. The underlying problems remain, and are even becoming worse as governments reinforce, even reward bad economic and financial behavior. The present Keynesian framework, although constantly touted as the only possible solution to the crisis, has only succeeded in making the inevitable crash much worse than otherwise would have been the case.

Nevertheless, there is a way out. It is still not too late to reverse course and implement a sound and rational program of economic recovery. The Capital Homesteading proposal developed by the Center for Economic and Social Justice ("CESJ") has the potential to reorient the global economy to comply with a more rational understanding of money, credit, and banking, and to establish and maintain an economically just future for all. Capital Homesteading includes a reform of the commercial and central banking systems of the world as an integral part of the program.

#30#

Own the Fed, Part XVII: The Age of Deregulation

A basic principle of internal control is that incompatible functions must always be separated. Internal control is the accounting term for the system that ensures that a business entity — or any other entity concerned with securing the safety of its assets, up to and including an entire economy — has the capacity to 1) safeguard its resources against waste, fraud, and inefficiency, 2) promote accuracy and reliability in accounting and operating data, 3) encourage and measure compliance with policy, and 4) judge the efficiency of operations in all sectors. Clearly, assigning incompatible functions to any individual, group, or institution is a way virtually to ensure not only that fraud can more easily be carried out, but that genuinely honest mistakes will not be detected and corrected.

The problem is that there are two types of control that can be used to regulate a system at any level — internal and external. The idea of internal control is to ensure that the system works in the way intended so as to match inputs and outputs, and to attribute to each input an accurate pro rata share of output based on the proportionate objective value of each input to the whole of the output. In other words, the system should be arranged in such a manner as to treat the contribution of each input with proportionate equality, e.g., an input responsible for producing 10% of the output is credited with 10% of the output. When extended to the whole of the social order, or even the economy, properly designed and implemented internal controls ensure as far as humanly possible equality of opportunity — a "level playing field."

When the system operates badly and distortions creep in — as is the case with assigning incompatible functions to different parts of a system (for example, a business in which the individual authorizing expenditures also has the power to sign checks) — some parts of the system will take unfair advantage of the other parts. This is often without conscious intent, or even contrary to what was intended, simply because of the way the system is set up. Unfairness gets built into the system.

Paradoxically, violating the system in order to gain a desired, even a just result, even when the system is unfair, is wrong. The proper response is to change the system so that it operates fairly, not to violate the system. This is called "social justice." Still, the temptation is always to try and correct an unjust system by overriding or eliminating the system, imposing external controls in an effort to achieve desired results. People in authority see that the system isn't working properly. They assume that the power of the State or some other institution can achieve the desired end by fiat.

This is not to say that there is no place for external controls. When individuals, groups, or institutions violate systemic (internal) controls deliberately, they must be held accountable. When a violation of the system is sufficiently serious or material, the State itself may be required to step in and punish the offender. This also applies in cases in which an individual, group, or institution violates the systemic controls without meaning to, for whatever reason. The State may find it necessary to correct the situation, or assist the individual, group, or institution to restructure the system so that the violation does not happen again, sometimes reinforcing the correction with the imposition of penalties.

Sometimes, however, the State or some other authority attempts to impose desired results as something other than a temporary measure or expedient while the system is being restructured. When that happens, not only does power become unnecessarily (and unacceptably) concentrated at the "higher" levels of society, but those levels — especially the State itself — reach functional overload, and the system implodes.

The State's job as an extremely specialized and powerful tool is to oversee and maintain the system of internal controls of the common good — the social order — so that the system works properly. The State should never, except as a temporary measure in an emergency and as an expedient, attempt to supply a lack in the system by mandating desired results or attempting to provide those desired results itself. Politics — the art of the possible — involves people coming together in communities (the "polis") and organizing matters so that each person may exercise his or her natural rights to the maximum without harming him- or herself, other individuals, groups, or the common good as a whole.

There is, however, a serious problem. Both of the two predominant schools of political thought today, broadly if inaccurately known as "liberal" and "conservative," deny humanity's character as a political animal. Briefly, Aristotle's observation that "Man is by nature a political animal" means that the human person is both an individual and a social being. As an individual, he or she has inherent or natural rights to assist him or her in the lifelong task of acquiring and developing virtue, and thereby becoming more fully human.

As a member of society, however, each individual has the responsibility of exercising his or her individual rights with an eye toward the common good. That is, even rights that are possessed absolutely are to be exercised only in a manner that does not harm the individual, other individuals, groups, or the common good as a whole. The common good is not the aggregate of individual goods or those goods held in common by the State for the sake of expedience. Instead, the common good is the complex network of institutions by means of which individual human beings are assisted in their task of acquiring and developing virtue.

Painting the picture in extremely broad strokes and necessarily oversimplifying, "conservatives" tend to view the human person solely as an individual, while "liberals" tend to hold that humanity is only important as a member of the collective. In the former case, the State is necessary in order to coerce (other) people into behaving, while in the latter, the State is essential as the embodiment of the collective will of the people.

The correct view, of course, is that the State exists to facilitate humanity's social interaction, maintaining the institutions of the common good, and adjudicating disputes, thereby providing a level playing field wherein every individual meets on equal terms, at least with respect to basic civil rights. It is not a weapon to use against others, or a universal panacea providing or guaranteeing all that the individual cannot do for him- or herself. Both the "liberal" and "conservative" viewpoints misunderstand the role of regulations, the former rejecting appropriate internal control in favor of inappropriate external control (collectivism), while the latter rejects all control, especially by the State, as inappropriate — anarchy.

Of concern to us in the context of the role of the central bank and the structuring of the financial system is that, whether in reaction to the "liberal" victories of the 1960s and 1970s, or for some other reason, the 1980s and 1990s seemed to embody a "conservative" backlash. "Deregulation" became the order of the day in order to achieve and maintain an environment suitable for business. In theory, this would result in economic growth and prosperity for all — a rising tide that lifts all boats.

Unfortunately, branding all regulation as undue interference on the part of the State tends to deny the State its proper — if extremely limited — role. The backlash failed to distinguish between regulations as necessary internal control measures, and intrusive misuses of State power. Consequently "regulation" became viewed as bad, in and of itself. All regulation was tarred with the same brush. The baby was thrown out with the bath.

It is true that some of the regulations that burdened the financial industry were efforts by the State to impose desired results. For example, "equal opportunity" in consumer lending, especially for housing, was often interpreted as meaning that lending institutions must lower their standards in order to allow people who otherwise were not good credit risks to qualify for loans.

Ironically, however, regulations attempting to impose desired results were not those targeted for repeal. Instead, regulations such as the 1933 Glass-Steagall Act, that inhibited or prevented financial institutions, especially commercial banks, from assuming incompatible functions and engaging directly in speculation, were seen as interfering with the growth and profitability of the financial sector — which was true, if we ignore the fact that such growth and profitability only comes at the expense of genuinely productive investment. As we've seen in this series, since the early 20th century people have confused speculation (gambling) and genuine investment.

It is not entirely clear what led to the overconfidence of the decades of the 1980s and 1990s. What is clear is that there was a concerted — and successful — effort to dismantle the internal controls that had been carefully put into place since the Panic of 1907. Deregulation was in many respects a good thing. The State is an extremely specialized and extraordinarily powerful tool. The State must, therefore, be carefully watched by the citizens to make certain that it does not begin to take over areas in which it has no competence and which are best left to the citizens themselves or, especially in social justice, to the design of the system.

Deregulation mania actually began before the 1980s, when the Securities and Exchange Commission mandated the deregulation of the brokerage industry on May 1, 1975. This opened up the door for the discount brokerage houses to undercut the traditional institutions, greatly decreasing costs for investors and speculators. This was a good thing in that it opened up the brokerage industry to competition and made the purchase of secondary debt and equity instruments for investment much easier for ordinary people. The "invention" of the mutual fund, made possible by the Investment Company Act of 1940, had done something similar a generation earlier.

Unfortunately, coming as it did into an environment in which far too many people were, frankly, ignorant of the difference between investment and speculation, the end result of brokerage deregulation was to make it much easier for ordinary people to lose a great deal of money in the belief that their gambling was actually allowing them to provide for their future. "How To" books on ways to make a fortune speculating on Wall Street proliferated. Some of these were (and remain) excellent guides on how to gamble — Peter Lynch's One Up on Wall Street (New York: Simon and Schuster, 1989) is superb — but only for people who know what they are doing and are fully aware that they are rolling the dice in a very risky and expensive game. Others are trash, luring people into purchasing a gambling system of which the only guarantee resembles the old joke of how to make a small fortune on Wall Street: start with a large one.

Just as unwise was the deregulation of the savings and loan industry beginning in 1979. This culminated with the passage of the Depository Institutions Deregulation and Monetary Control Act of 1980, and the Garn-St. Germain Depository Institutions Act of 1982, which partially repealed Glass-Steagall. This was not, of course, the 1932 Glass-Steagall that provided the legal justification for the complete switch from a money supply backed by private sector hard assets to government debt (external control). This was the 1933 Glass-Steagall that instituted separation of function of different types of financial institutions (internal control).

Deregulation permitted savings and loans not only to provide a broader range of savings vehicles for their depositors, but to make loans in areas formerly considered outside their competence, such as commercial real estate. This allowed many savings and loans, forgetting their specialized character, to diversify away from residential real estate (their traditional area of expertise) and try to cash in on the real estate boom of the 1980s.

Manipulation of the interest rate by the Federal Reserve only added to the problem. Chairman Paul Volcker began raising short-term interest rates late in 1979. Suddenly, returns on short-term loans were higher than those on long-term loans, such as the home mortgages (many with low fixed interest rates) that were the specialty of savings and loans. This encouraged savings and loans to engage in short-term speculation in commercial real estate in order to maintain or increase their profit margins rather than long-term consumer finance that was their mainstay. The problem, known as "Asset-Liability Mismatch," got worse as interest rates soared in the early 1980s. When the real estate bubble burst, the market took many savings and loans down with it.

Despite the obvious failure of deregulation that accompanied partial repeal of Glass-Steagall, the banking industry continued pushing for full repeal. In 1987 the Congressional Research Service prepared a report that presented the case both for and against full repeal. The reasons as stated are revealing. They exhibit a distinct lack of appreciation on both sides of the real issue involved: whether a society is to be organized on the basis of internal control imposed by the proper and rational structuring of the system itself (social justice), or whether desired results will be imposed by State mandate (socialism).

Unfortunately, the arguments in favor of keeping Glass-Stegall on the books were seriously weakened by taking the tenets of the Currency School for granted. This, however, should have made no difference, had the powers-that-be truly understood the difference between internal and external controls, or (more fundamentally) where sovereignty truly lies: with the people, as opposed to the State. Still, the arguments against full repeal were, within the limits noted, compelling. They should have carried the day had not the banking industry continued to exert pressure to repeal Glass-Steagall in search of speculative profits:

First, there is a serious conflict of interest when the same institution both grants credit and controls the use of the credit. This led to the abuses that originally justified Glass-Steagall. (This is the same issue that every business must address by separating the department and the individuals responsible for authorizing disbursements and for making the disbursements.)

Second, banks exercise great power over other people's money. This control over what belongs to other people must be limited to ensure that both loans and investments are sound, and that there is an adequate level of competition for both in the market. (This is a little off-base. Commercial banks do not, in general lend deposits, but use deposits as reserves and create money backed by fractional reserves by issuing promissory notes. This does not, however, change the point: combining different types of financial institutions, especially commercial banks and investment banks, eliminates competition and removes an essential level of scrutiny.)

Third, dealing in securities can be risky, leading to great losses. Such losses can threaten the safety of deposits. Because the federal government insures deposits, a collapse of the system could result in the government (i.e., the taxpayer) having to bailout the financial system. (This confuses investment and speculation, but the point is well taken. Permitting financial institutions to create money at will for speculation, as happened in the Crisis of 1920 and the Crash of 1929, destabilizes the financial system and undermines the economy — which runs on production, not speculation.)

Fourth, and finally, depository institutions (again the confusion between banks of deposit and banks of issue — commercial banks) are supposed to be run in the interests of their shareholders and depositors. This means limiting unnecessary risk. Bank managers are not trained to operate prudently in the more speculative types of securities. (The slight confusion in the roles of different types of banks makes no difference; the point remains the same: commercial banks are supposed to make loans for qualified industrial, commercial, and agricultural purposes, not gambling.)

Against these more or less solid — if not quite accurately stated — arguments, the banking industry countered with the following points:

First, the financial industry is losing money to un- or less regulated securities firms and foreign competitors that are not subject to Glass-Steagall. The industry needs deregulation in order to compete effectively and maintain and increase profits. (That is, poachers are stealing profits. Instead of demanding that internal controls apply equally to anyone engaged in securities dealings on the secondary market, internal controls should be removed. Two wrongs are necessary to make a right.)

Second, conflicts of interest can be eliminated by enforcing the laws prohibiting them, and by separating functions within a single financial institution. (That is, institute less effective external control by the State in place of more effective internal control by the system, and permit financial institutions to replace effective systemic controls with ineffective nominal separation of function.)

Third, the proposed securities activities are low risk, and diversification would reduce total risk in any event. (Neither of these assertions was true. Speculation is always high risk; the proposed activities were only "low risk" in comparison with other speculative ventures — and were not confined to "low risk" speculation in any event. Further, "diversification" was grossly inadequate if not misleading, being based not on spreading risk, but on betting on which securities would be "losers" through the use of hedging.)

Fourth, and finally, the financial industry argued that commercial banking and investment banking was common throughout the rest of the world, and operated successfully in both the banking and the securities markets. The U.S. financial industry could learn from the system in other countries and apply the lessons in structuring domestic regulations. (The obvious response to this is what your mother always asked when you wanted to do something unwise just because your friends were doing it: "If so-and-so jumped off a cliff, would you?" Further, not only were and are foreign financial markets not all that well run — usually relying on direct State support if not outright connivance between the public and the private sector elites to maintain a semblance of stability — the U.S. financial industry failed to learn anything.)

The pressure the banking industry exerted on Congress was evidently too much. On November 12, 1999 Congress enacted the "Gramm-Leach-Bliley Act" ("GLBA"), officially the "Financial Services Modernization Act of 1999." GLBA allowed the formerly carefully separated commercial banking, investment banking, and insurance industries to combine in a single monolithic entity of incredible power — the "financial services industry." GLBA also allowed financial holding companies to own non-financial institutions as long as they are not corporations.

All of this had already been permitted on a temporary basis under a waiver issued in 1995, under an amendment to the provisions of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (IBBEA) that was made effective February 7, 1995. The IBBEA repealed the interstate restrictions of the Bank Holding Company Act of 1956. The IBBEA permitted interstate mergers of "adequately capitalized and managed banks, subject to concentration limits, state laws and Community Reinvestment Act (CRA) evaluations."

Perhaps the most spectacular combination — a virtual "financial trust" that rivaled J. P. Morgan's influence and power before the Panic of 1907 — was the formation of the Citigroup conglomerate in 1998. This combined Citicorp, a commercial bank holding company, and Travelers Group, an insurance company, which offered a complete range of financial services from commercial banking, investment banking, brokerage services, and insurance. Had it not been for the temporary waiver, the combination would have violated not only Glass-Steagall, but also the Bank Holding Company Act of 1956. Technically, then, GLBA did not permit combinations, but legalized those that had already occurred under the waiver and made them permanent.

Thus, in the name of free market reforms, the last vestiges of freedom were removed from the market. Those pushing for deregulation seem to have had little appreciation for the power of the system to regulate itself if structured properly. As "free" market adherents continue to believe to this day, they assumed that something they vaguely call "the free market" will somehow take care of itself. This is presumably accomplished without careful popular oversight of the system, and without bothering to put adequate internal controls in place or maintain those that already exist.

Ironically, removing internal controls that allow the system to regulate itself necessarily results in the State imposing external controls when the inevitable abuses and mistakes occur. The end result is to put the market completely under the control of the State through the imposition of often arbitrary external controls, putting the financial system — and thus the economy — at the mercy of those who control the State.

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Own the Fed, Part XVI: Steps Back and Forward

Matters seemed to have calmed down as the sixties ended. All in all, things had probably never been better. No one had ever heard of AIDS, and Arabs were somewhere on the fringe of global society, providing the world with cheap oil following the humiliation of the Islamic world in the brief 1967 war with Israel. As for terrorism, the most the Provisional IRA had accomplished was to blow up Lord Nelson's column in Dublin on March 7, 1966. The feat didn't do anything for a united Ireland, but it earned them a comic song written by Tommy Makem and premiered by him and the Clancy Brothers in a special concert held in Dublin on the 50th anniversary of the Easter Rebellion of 1916.

From the point of view of economic justice, to say nothing of common sense and reality, however, the situation was unstable at best, and could only become more so. At the very beginning of the decade, on August 15, 1971, President Richard Nixon announced wage and price controls in an attempt to control the demand-pull inflation caused by the increased spending to implement the Great Society and carry on the war in Vietnam at the same time.

Whether as a result of having offended the laws of economics laid down by Mammon and Pluto as well as common sense, or simply because it was Nixon, almost immediately a series of events occurred that caused a wave of cost-push inflation. Authorities blamed the failure of the Peruvian anchovy fisheries in 1972 as the first major event in what has been called an "economic shock wave." Peruvian anchovies in the form of fishmeal were and remain a major source of animal fodder, and an important export.

The next blow is the one that for many people symbolizes the 1970s the way that Woodstock exemplifies the 1960s. This was the "Oil Crisis" that began in 1973. The Organization of Petroleum Exporting Countries — "OPEC" — began to restrict the supply of oil throughout the world.

Both the natural Peruvian anchovy shortage and the engineered OPEC oil shortage had near-catastrophic results. This was principally on the availability of raw materials, making them actually (in the former case) or relatively (in the latter case) scarce, and driving up the cost of inputs to production in two critical sectors, industry and agriculture, across the board. Added to this was a general overall energy shortage throughout the decade. Because of the wage and price controls, many consumer goods were in short supply — long lines appeared at gas stations, and industrial costs increased rapidly, narrowing and, in some cases, completely wiping out profit margins.

The stage was set for "stagflation." Stagflation is a combination of unemployment and inflation caused by State interference in the economy. The condition is considered impossible under Keynesian assumptions. Stagflation is, however, perfectly understandable, given an analytical framework provided by binary economics, or even the basic tenets of the Banking School.

Specifically, stagflation is when both inflation and unemployment are high. Ordinarily, Keynesian economics posits a tradeoff between these two presumably mutually exclusive conditions. Because the Keynesian framework does not allow for stagflation, there are no methods of dealing with it within that paradigm. Consequently it is extremely difficult to stop once it gets started. It is therefore extremely costly in both human terms as well as in the scale of budget deficits it engenders.

There are believed to be two major causes of stagflation, both of which were present in the 1970s. One, there is a "unfavorable supply shock." This results in raising prices at the same time that the rising costs of inputs makes production less profitable. In the 1970s there were at least two major "supply shocks" that affected industry and agriculture: the failure of the Peruvian anchovy fisheries, and the manipulation of the oil supply by the OPEC cartel.

Two, the combination of stagnation and inflation can result when the State implements inappropriate macroeconomic policies, that is, attempts to control the economy to go in a direction in which the economy doesn't want to go. Nixon managed to combine two policies that contained inherent contradictions, 1) massive money creation by the Federal Reserve to finance both the Vietnam War and the Great Society, both inherited from previous administrations, and 2) imposing wage and price controls or other interference with the market mechanism. In this category we have to include trade barriers, raising the minimum wage, and so on.

The latter policy can, in fact, be blamed on Nixon — but not the disastrous results. Evil as he is presumed to have been by many people, "Tricky Dick" could not have predicted either the failure of the Peruvian fisheries or the enormous increase in oil prices that triggered the stagflation. Yes, the attempted interference with the semi-free market in the United States made the situation infinitely worse than it otherwise would have been, but there was no way that could have been foreseen. Nixon, despite his famed declaration to the effect that "now we are all Keynesians," is also not truly responsible for attempting to apply the presumably effective Keynesian corrective in the form of a massive infusion of stimulus money to counteract the recession that resulted — and which caused a wage-price spiral.

From any perspective, the solution to stagflation is 1) either to find new sources for the materials in short supply or develop substitutes, and 2) "adjust monetary policies," which in English means calling a halt to inflationary money creation to finance government deficits or consumer spending, restricting new money creation to financing new capital formation. The latter is easier said than done. Most governments since the 1930s have become, in effect, "money addicts," relying on perverting the commercial and central banking systems to provide the massive transfers of purchasing power to fund government spending, and are willing to let taxpayers and consumers bear the costs, both hidden and direct.

Consequently, it was not until the early 1980s that stagflation began to ease, helped in no small measure by improvements in the efficient use of energy and increases in global oil production. There were also cutbacks in government spending and moderate changes in monetary policies that contributed to the end of stagflation and led to what turned out to be the illusory prosperity of the 1990s.

One result of the stagflation of the 1970s was a renewed insistence that the State could solve all of our problems if only it had enough power and tried hard enough. There was another push to implement the provisions of the Full Employment Bill of 1946 that had been emasculated into law as the Employment Act of 1946. In 1978 the Humphrey-Hawkins Full Employment and Balanced Growth Act amended the Employment Act of 1946. There was, to all intents and purposes, no difference between the Humphrey-Hawkins Act and Murray's Full Employment Bill of 1945. Both sought to put total responsibility for economic stability on the State, both tried to provide an absolute guarantee of full employment and to vest the State with the economic means to achieve this end.

Despite Hubert Humphrey's reputation and status as "the Happy Warrior," the Full Employment and Balanced Growth Act was no more successful than the Employment Act of 1946. Believing in absolute State power to achieve any goal is no substitute for truth or empowerment of ordinary people, despite Keynes's claim that the State has the power to change reality by "re-editing the dictionary."

The one real advance in the 1970s is one that has received little recognition, even from those who have benefited most from it. There has been virtually no appreciation of the revolutionary nature of the passage of the original enabling legislation for the Employee Stock Ownership Plan ("ESOP") signed into law on January 1, 1974. Nevertheless, the passage of the first ESOP law — although to date more of a promise of things to come than an actual revolution — signaled the possibility of a change in the direction of the whole of society so profound as to undermine what has been accepted as absolute truth for more than four centuries (not four-thousand, as Keynes asserted), and to deliver real hope to the majority of the human race who have been kept in a condition of dependency as a result of lack of access to the means of acquiring and possessing private property in the means of production.

After that buildup, some people might see the story itself as almost a letdown (too bad for them) — but it helps demonstrate the power that even a few people can have to effect changes in the social order if organized and properly motivated, and if they base their actions on universal moral values and sound economic principles, especially as found in binary economics.

The meeting on November 27, 1973 between "ESOP inventor" Louis Kelso and Senator Russell Long in the Montpelier Room of the Madison Hotel was a watershed event in the effort to reorient the economy and the financial system to return to its sound Banking School roots and the American tradition of widespread ownership of the means of production — to say nothing of restoring money power to the people.

In the early 1970s, Kelso and Norman Kurland (now president of the Center for Economic and Social Justice, "CESJ") began focusing on Capitol Hill. Senator Fred Harris of Oklahoma became interested in Kelso's ideas. He had a number of Kelso's articles as well as responses to Samuelson's attack on Kelso read into the Congressional Record.

In 1972 representatives of the National Maritime Union (NMU) hired Kelso and Kurland to advise them on a plan to save passenger vessel industry after the government cut off operating and construction subsidies, throwing 5,000 NMU members out of work. NMU president Joe Curran testified before the Senate Maritime Affairs Subcommittee, saying that his union was prepared to cut labor costs by 50% if the Congress would cooperate in helping them adopt the Kelso plan to save the industry. The committee studied the matter. Ironically, the committee chairman, Senator Russell Long of Louisiana, rejected the idea, remarking that it "sounds like one of my daddy's programs, 'make every man a king.'"

Through the combined efforts of George and Charlie Pillsbury — father and son at different ends of the political spectrum (Charlie was Gary Trudeau's roommate at Yale and provided the model for Trudeau's "Doonesbury" character) — a door was opened to Senator Paul Fannin of Arizona some months later. Kurland met with Fannin, who immediately saw the political significance of Kelso's ideas — especially the aspect that citizens who own no corporate equity would be extremely hostile to corporate profits. Fannin easily understood Kelso's "pure credit" financing method, i.e., credit extended for productive purposes by commercial banks without using existing accumulations of savings and rediscounted at the Federal Reserve.

Fannin arranged for Kelso to make a presentation to a number of conservative members of the Senate Finance Committee. Long, the chairman, did not attend, but the "Accelerated Capital Formation Act" went through under Fannin's sponsorship. This was a success, even though the bill did not get very far, for it brought the ideas to the attention of members of both parties. With the Fannin legislation Kelso and Kurland went to work building broad-based support to get around Long and Congressman Wilbur Mills, head of the House Ways and Means Committee, as attempts to meet with both men had been unavailing.

In February 1973 Kelso and Kurland testified on legislation to save the Penn Central Railroad, at that time in a state of near financial collapse. The only choices seemed to be either to nationalize, or provide government subsidies to benefit existing shareholders and the unions — the former unacceptable, the latter politically untenable. Kelso and Kurland gave the Congress a Just Third Way: convert the Penn Central to a 100% worker-owned railroad using an ESOP, restructuring the labor agreement as a prototype for Justice-Based Management ("JBM"). In addition to regular wages, workers would share ownership and profits. The plan was adapted from the proposal developed for the National Maritime Union.

When Kelso and Kurland testified on February 28, 1973, Senator Vance Hartke of Indiana, who chaired the committee, told Kelso, "You know, these ideas are really interesting, they're provocative, they're positive. It isn't often that we hear good ideas. But you'll never sell this idea to the Congress." Kelso and Kurland continued working to persuade committee staff, but with limited success.

Then in August Senator Mark Hatfield of Oregon wrote a Washington Post article, "Six New Directions for America," with the Kelso ideas of basing economic and stability on expanded capital ownership — evidently some of the seeds dropped by Kelso and Kurland over the previous months had taken root, and someone had carried the ideas to Hatfield.

Kurland visited Hatfield's office and convinced Hatfield to sponsor a proposal to convert Conrail into a 100% worker-owned company. With Hatfield's agreement to sponsor the legislation, Kurland began rounding up support from both sides of the political spectrum — Senators Curtis, Hansen, Metcalf and Humphrey, all of which agreed to be co-sponsors. The Senators were all very important and in critical positions . . . except that none of them was on the right committee. Progress stalled.

Meanwhile, however, an important constituent in Louisiana had made contact with Wayne Thevenot, Long's executive assistant. The constituent had read Two-Factor Theory (op. cit.) and became convinced that Kelso's ideas had the potential to solve major problems. He met with Thevenot, and persuaded him to try and convince Long that Kelso's proposals were, contrary to his previous statement, the right thing to do for the country. As the story was related to Kurland later, Long opened up a copy of The Capitalist Manifesto, flipped through the pages, and stated, "I want to meet these people."

On November 26, 1973, Kurland picked Kelso up at the airport for a meeting the next day with Long. On the way back from the airport they were listening to the radio, and heard Eric Severeid ask, "Casey Jones, where are you?" Based on materials Kurland had sent him, Severeid delivered an editorial supporting the Kelso proposal for the Conrail system. Severeid didn't mention Kelso or Kurland, but named Senator Hatfield. The next day, Kelso and Kurland met Long coming out of a debate, and the senator invited them along with Thevenot to dinner at the Montpelier Room at the Madison Hotel in Washington, D.C. This was at a time when even the most important lobbyists were lucky to get five minutes. Kelso and Kurland spent four hours with Long — and Long picked up the check.

Kelso spent about three quarters of an hour explaining his general theory, political theory, and the logic of binary economics. Long then compared Kelso's ideas with those of his father's "Share Our Wealth" program. Long's father, Huey Long, senator and former governor of Louisiana, was an extremely charismatic populist — at one time he was voted "the most attractive man in America" after Edgar Rice Burrough's fictional character Tarzan of the Apes. Huey Long, the "Kingfish," was murdered at a time when his criticism's of FDR's New Deal had become extremely pointed and vocal.

Russell Long then discoursed for two hours on his own philosophy, making it clear that he differed from his father by not being a "Robin Hood populist." Long, however, liked the idea of every person being a capital owner, although he insisted on using the vague term, "capitalist." At the end of his talk, Long asked Kelso who opposed Kelso's ideas.

Kelso answered that traditional economists opposed his economic theories — that his ideas challenged their paradigms. Kelso mentioned Milton Friedman and Paul Samuelson by name. Kurland remembered Senator Long's response: "One of my basic principles that I had from the time I first entered politics is that I don't care who's right, I care what's right. This is right."

Then Long turned from Kelso to ask, "What are you people doing about it?" Until then, Thevenot and Kurland had remained silent, letting the dialogue flow between Long and Kelso.

Kurland said, "Senator, we have a bill before Congress dealing with the railroads. Senator Hatfield is the principal sponsor, and we have Senator Humphrey and Senator Metcalf from the Democrats, and Senators Curtis and Hansen from the Republicans, who are co-sponsors. But the bill is not going to go anywhere. We know that. We've talked to the staff and haven't got anywhere. We know that anyone can introduce a bill, but we know that it's going to take more than that to get it passed. We need the right person who's a member of the Commerce Committee, somebody with the courage and the power to take our proposal and convert it into law."

Long then asked Kurland to bring him something the next morning. The next day, Long took the package to a meeting of the Commerce Committee and announced that he had an answer to the railroad problem. A number of the senators responded enthusiastically when Senator Warren Magnuson of Washington, the chairman of the committee, reminded Long that the meeting had not yet been called to order. Long responded, "Well, I'm really busy. I've got another meeting down the hall, and . . . this is the answer!"

Lynn Sutcliffe, staff director of the Surface Transportation Subcommittee, objected: "You know, Senator, I've been hearing these ideas from Kelso and Kurland and really, there are a lot of problems."

Kelso and Kurland had, in fact, been speaking to the unions involved with the railroads. The sixteen unions had invited Kurland to speak before them at the AFL-CIO meetings in Miami Beach. Kelso and Kurland had one of the unions, the Brotherhood of Railway and Airline Clerks, supporting the idea but the other fifteen unions — the Teamsters, Transportation Workers, etc. — had worked out their own deal with the railway executives, both sides collaborating to take the money from the taxpayers in the form of government subsidies. Organized labor was not yet ready to support Kelso, and had conveyed their opposition to Sutcliffe.

Long cut Sutcliffe short, responding, "You're telling me about problems. Problems. That's all I deal with every day. Don't tell me about problems. This is the solution!" Sutcliffe had nothing else to say.

It wasn't until December that the ESOP legislation was introduced into the Senate. Long had to fight for it. Senator Javits, who didn't like the ESOP or Kelso's ideas, was ready to oppose the legislation. Before Javits could voice this on the floor of the Senate, however, Long walked over to him (Kurland observed the action from the gallery) and put his hand on Senator Javits's shoulder and spoke to him in a low voice, telling him that if he, Javits, opposed the proposal, he, Long, would denounce him on the floor of the Senate as an enemy of the American worker. Javits, not wanting to be viewed as an enemy of worker ownership, took the hint and remained silent.

Long managed to get a watered-down piece of legislation into law. It didn't call for 100% employee ownership. It merely called for a study to determine the extent to which the employees should be owners. Kelso and Kurland wrote the criteria for the study, figuring that the only conclusion any objective group could possibly have was that there should be 100% ownership by the workers. In December the legislation calling for an ESOP study was passed. President Nixon signed the measure into law on January 1, 1974.

While Kelso and Kurland succeeded in establishing a beachhead for the ESOP, the powerful forces of the status quo fought back. The Department of Transportation awarded the ESOP study to the investment banking firm E.F. Hutton; a leading firm on executive compensation, Towers, Perrin, Foster and Crosby; and a labor economist, Saul Gellerman. This team wrote a report concluding that nothing positive would result from the use of an employee stock ownership plan for the railroads. Kelso and Kurland later had an opportunity to provide a point-by-point rebuttal that was included in testimony before the Joint Economic Committee in 1976, when Senator Hubert Humphrey held two days of hearings on ESOPs.

The rest is history. Because of Long's championing of the ESOP and the ideas of Louis Kelso, there are more than twenty U.S. laws promoting ESOPs including the cornerstone Employee Retirement Income Security Act of 1974 (ERISA). Today there are over 10,000 ESOP companies with over 11 million worker-owners.

The meeting between Senator Russell Long and Louis Kelso, the events leading up to the meeting, and the events that followed, demonstrate that "prime mover" support is crucial for an idea that is as revolutionary as Kelso's. This is especially true for an idea that still lacks credibility among academics, particularly academic economists.

To move systemic change forward with any degree of speed takes authentic leaders — people with power, people with courage, people with principle and vision. Such leaders must first be willing and able to challenge the forces of the status quo, to do what is morally right, to go over the heads of the opposition and communicate on moral grounds directly to the public. Russell Long became the prime mover behind the Kelso revolution.

Today, prime movers like Russell Long are needed more than ever to realize the full potential of Louis Kelso's remarkable vision to achieve economic empowerment for all through broad-based direct capital ownership.

(The portion of this posting dealing with Kelso and Kurland's efforts to promote the ESOP is taken from "Dinner at the Madison" by Norman G. Kurland, an eyewitness to the events described.)

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News from the Network, Vol. 3, No. 13

From one perspective, it is the most frightening news we could hear: Timothy Geithner is hedging his bets. As an April 1, 2010 Washington Post article put it, "Geithner: Disparity in recovery 'deeply unfair'." The article is essentially a "pre-excuse" in order to divert the blame when the so-called recovery turns sour — as indeed it must, as it is not backed up either by sustainable production or an increase in productive capacity.

Yes, business has been "growing" over the past ten months or so, but 1) it's only replacing inventory, and 2) America's industrial base, even if it reached full output, is a shadow of its former self. There are few people alive today who remember (or who bother to find out) that in 1933 — generally considered the worst year of the Great Depression — industrial output was "recovering," showing gains in a number of months. Of course, the economy suffered another serious downturn three years later when the Federal Reserve raised its rates to dampen down the overheated economy because the authorities decided that the recovery was proceeding too fast.

Adding to the problem is the anticipated cost of the new health care mandate. The Obama administration appears to have failed to take into account that ordering employers to pay for workers' health care is a tremendous incentive to get rid of workers and replace them with cheaper foreign workers or more efficient (or at least cheaper and more tractable) technology. The "write down" controversy pales in comparison with the uproar that will ensue when workers find themselves priced out of the labor market.

If that were not enough, business folk as well as the speculators on Wall Street are desperately trying to predict when Federal Reserve Chairman Bernanke is going to raise interest rates. (This may also account for the reported rise in business activity, as businesses rush to borrow now at low interest rates in anticipation of a raise in rates, hoping that they will be able to sell what they have produced.) Raising interest rates is the standard tool the Federal Reserve uses to reduce lending for speculative purposes, presumably preventing bubbles from forming. The problem is that putting on the brakes by raising all interest rates means starving the productive private sector for credit in order to inhibit or prevent speculation.

Financial institutions are then forced into an "Asset-Liability Mismatch." They seek out places to put their money that have higher (and increasingly speculative) returns in order to cover the higher cost of that money. This, in part, is what led to the savings and loan crisis of the 1980s. As that experience demonstrates, raising interest rates to inhibit or prevent speculation actually encourages speculation — and, as happened in the mid-1930s and early 1990s, precipitates an economic downturn . . . at a time when we are still in the process of trying to recover from the last one.

We might be tempted to say that the "mini-depression" of the mid-1930s and the recession of 1990-91 weren't all that bad. After all, the economy recovered, didn't it?

Yes and no. The monetary and fiscal policies of the New Deal didn't bring the country out of the downturn of the mid-1930s. World War Two did that. As for the savings and loan debacle, that directly affected only a relatively limited sub-sector of the financial markets. While the final bill was large, in the neighborhood of $160 billion, and is blamed for precipitating the recession of '90-91, most of the economy remained more or less sound, making for a relatively rapid recovery.

That is not the case today. We do not have an Adolph Hitler to start a genocidal war that requires full mobilization of all resources to give us a fighting chance to survive. Neither do we have a basically sound economy to cushion us from the failure of a relatively limited portion of the financial sector. What we do have is an economy, such as it is, from which a large measure of productive capacity has been taken away, and which the State seems intent on further undermining. Perhaps that is what Geithner sees, and why he appears to be so intent on excusing himself and trying to fix the blame elsewhere for the United States pursuing its current suicidal economic policies. He doesn't want to be strung up from a lamppost when the inevitable crash occurs.

What is the solution? Obviously, we need to rebuild what Harold G. Moulton termed "America's Capacity to Produce" (Washington, DC: The Brookings Institution, 1934). That, however, is not enough. We also have to rebuild "America's Capacity to Consume" (Washington, DC: The Brookings Institution, 1934). This will require a full mobilization of resources such as we have not seen since World War Two — but it can be done. Both of the goals can be accomplished at the same time by implementing Louis Kelso and Mortimer Adler's "Proposal to Free Economic Growth from the Slavery of Savings." Every man, woman, and child must be given the opportunity to produce through direct ownership of both labor and capital, thereby supporting the consumption from which the demand for capital is derived.

Consistent with Say's Law of Markets, producing in a way in which everybody participates through ownership in and of itself restores consumption to the necessary sustainable level, building and maintaining a sound economy. This is the program outlined in Capital Homesteading for Every Citizen, a copy of which should go to every Congresscritter and Senator on Capitol Hill.

What can you, personally, do to help bring about a sound economic recovery before the powers-that-be manage to fumble the ball and lose the game in the few remaining seconds? Open doors for the CESJ core group to make a presentation of Capital Homesteading to prime movers, or those who can get members of the core group to prime movers. You never know just what connection is going to pay off — and your political chips increase the more you connect the right people, as "Dinner at the Madison" demonstrates.

What have we been doing? As much as we can, even though many things have slowed down, both because of the holiday weekend, and because of our preparations for the annual peaceful rally at the Federal Reserve:

• The annual peaceful rally at the Federal Reserve is scheduled for Thursday, April 15, 2010. Reservations are not required, but let us know if you plan to attend so we can send you directions and instructions. Contact information is on the CESJ website.

• CESJ has received an inquiry about its internship program from Johns Hopkins University in Baltimore. CESJ is always seeking motivated self-starters for its internship program.

• If you are not pursuing a formal course of study, or you do not need credit hours yet have a Just Third Way project or want to help carry out an existing initiative (such as door opening, research, arranging a speaking engagement, or getting coffee and making copies), consider becoming a CESJ volunteer.

• CESJ's research library recently obtained a rare copy of Harold G. Moulton's The Recovery Problem in the United States (1936). The book contains many insights on the Crash of 1929, the Great Depression, and the missteps in the New Deal recovery programs.

• We received a most encouraging telephone call this week from a retired lady in New Jersey, who told us how helpful the current "Own the Fed" series was in helping her understand how the central bank of the United States had been diverted from its original mission of providing the private sector with an elastic currency sufficient to meet the needs of industry, commerce, and agriculture without inflation or deflation. Her only problem was that she was having difficulties in getting people sufficiently interested in what we have to say to go to the CESJ website and this blog. This is door opening on an individual level, and can be the most effective way to get the ball rolling — you never know who may be listening.

• As of this morning, we have had visitors from 48 different countries and 47 states and provinces in the United States and Canada to this blog over the past two months. Most visitors are from the United States, Canada, the UK, Brazil, and India. People in Venezuela, France, Rwanda, Finland, and Ghana spent the most average time on the blog. The most popular postings are "Thomas Hobbes on Private Property," Guy Stevenson's "Expanded Capital Ownership Now," "The Crash of 1929" in the "Own the Fed" series, "Henry Ford and John Maynard Keynes," also in the "Own the Fed" series, and "A Rare Chance to Remake the Fed."

Those are the happenings for this week, at least that we know about. If you have an accomplishment that you think should be listed, send us a note about it at mgreaney [at] cesj [dot] org, and we'll see that it gets into the next "issue." If you have a short (250-400 word) comment on a specific posting, please enter your comments in the blog — do not send them to us to post for you. All comments are moderated anyway, so we'll see it before it goes up.

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Own the Fed, Part XV: The Great Society

With the advent of the 1960s and the election of John Kennedy to the presidency of the United States, winds of positive change seemed to be blowing away the general malaise of the 1950s, a "New Camelot." Despite the superficial complacency of the previous decade, there were deep undercurrents of stress and discontent not only in the United States, but throughout the world. Worry over communism, civil rights, the ossification of American beliefs and attitudes, particularly in academia — a mental shutdown that came a little earlier than Allan Bloom chronicled (The Closing of the American Mind. New York: Simon and Schuster, 1987) — but especially the growing dependence of a free people on the State — "The System" — which was rapidly reaching the point of functional overload were all symptoms of something off track somewhere. All these things and more signaled something inherently wrong with the social order and humanity's place in society, especially with respect to the economy.

The Hippies were right on at least one thing — there was (and remains) something wrong with The System, man . . . as well as with The System Man. By and large, people, deprived of the control over their own lives and alienated from others through the loss of meaningful private property stakes, had bought into their new dependency status. The "American Dream" subtly changed from sole proprietorship of a farm or small business (an integral part of the community, both politically and economically), to a well-paying wage system job, a house, and a two-car garage.

These are all very nice things to have, but they do nothing to connect anyone directly either to the political or the economic process. Like Charlie Chaplain's character in Modern Times (1936), one becomes — literally — a cog in a machine, replaceable at the will of whoever happens to hold power at the moment. The theme of alienation is pervasive throughout 20th century literature, increasing as the century wore on and more and more people were forced out of direct ownership of the means of production and into the wage and welfare system.

Younger people had not been conditioned to the loss of liberty occasioned by lack of access to the means of acquiring and possessing private property in the means of production. Without the fear engendered by personal experience of the Great Depression and the World War, the generation born since the war was understandably uncomfortable with the conformity the system imposes on anyone who lacks the power to resist. As "power naturally and necessarily follows property" (Daniel Webster, The Massachusetts Convention of 1820), the American middle class was to all intents and purposes powerless, and increasingly dependent on the State to maintain them in their positions. The 1950s rebels without a cause became rebels with a very definite cause in the 1960s: change or destroy an increasingly inhuman system.

While this is only a guess, it's possible that the growth of materialism and consumerism that so turned off the younger generation in the sixties may have been in response to the loss of real power coincident with loss of ownership of the means of production. People may unconsciously have been trying to convince themselves that they weren't quite as powerless as they believed, not if they could acquire some of the increasingly abundant flood of consumer goods and services that made their appearance as technology began rapidly advancing.

Of course, most of them didn't own the technology that was producing the abundance. This caused Say's Law to malfunction. Instead, the propertyless majority relied on an employer or a union backed up with the coercive power of the State to obtain what they considered their fair share. Increasingly, gaining one's "fair share" meant redistributing what the traditional rights of property would have said belonged exclusively to the owner.

As we have already seen as the 20th century advanced, lack of ownership of technology just as technology had the capacity to replace a large measure of human labor in the production process threw a great deal of sand into the economic machine. The sabot that socialism tossed in only made the situation worse. The Keynesian framework requires that effective demand be maintained at adequate levels, regardless of the source of the demand, but usually relying on some form of redistribution through inflation or taxation. Say's Law of Markets, of course, explains that effective demand results from our production of marketable goods and services, which we exchange for the marketable goods and services produced by others through the medium of "money" in a variety of forms.

Locked into the dogma that only existing accumulations of savings can be used to finance capital formation, however, and that only coin, currency, and demand deposits constitute "money," there is a Keynesian tightrope that has to be walked. If you do not redistribute enough effective demand (again, whether through inflation or taxation, depending on what people will stand for), goods and services remain unsold, and business goes into a downturn.

If you redistribute too much, businesses cannot finance new or replacement capital, goods and services are not produced, and business goes into a downturn, and you get inflation besides, as excess effective demand bids up the price of the inadequate supply of marketable goods and services. This is what Moulton called "the economic dilemma" in The Formation of Capital (op. cit., 26-36), concluding that it is an artificial choice forced on people by bad assumptions about the way capital is financed.

What happened during the 1960s was that policymakers were confronted with the Keynesian dilemma that a country cannot produce both "guns and butter," as the case is usually explained in economics texts. As we might expect, the "guns or butter" decision is predicated on the dogmatic (and disproved) belief that there exists only so much in the way of accumulated savings. Consequently a country cannot produce beyond the limits established by the "production possibilities frontier," at least for any sustained period. "Guns or butter" is a way of saying that an economy must choose between using its limited financial resources for defense spending, or to produce consumer goods.

The "Great Society" of the 1960s attempted to eliminate poverty and racial injustice — government-run efforts that (as we might expect) required vast amounts of money, as does every government program ever invented. While elimination of poverty (except through direct ownership of the means of production) and promotion of civil rights (except for the right to direct ownership of the means of production) were primary objectives of the effort, major spending programs also included education, medical care, urban renewal, transportation, consumer protection, the environment, as well as arts and culture.

In many respects, the Great Society might be considered a continuation of the New Deal, carrying it forward into a new generation, at the same time expanding both the scope of the programs as well as the role of the federal government. This led to "neo-conservatism" as a reaction, but the "neo-cons," by and large, differ from traditional liberals only in what they want the State to do, not in their basic assumptions or the degree of State involvement in the economy or the daily lives of people.

Politicians who opposed the war in Vietnam claimed that the spending required to sustain the conflict was taking funds from the Great Society and limiting its effectiveness. On the contrary, whatever the morality or justification of the Vietnam War, cost was not an issue within the Keynesian paradigm — at least not in the sense of draining resources from social programs. The Great Society programs as well as the war were both abundantly funded by creating massive amounts of new money backed by government debt and running up the government deficit.

This, of course, raises the question as to how, if the "guns v. butter" dilemma is inescapable — as the production possibilities curve insists must be the case — how was it possible to have both guns and butter not only during the 1960s, but ever since? Keynesian doctrine claims that even redistribution through inflation or the tax system cannot change the parameters established by the productions possibilities curve. Inflation and taxation can shift demand around, they can even change ineffective demand to effective demand, but they cannot increase aggregate demand — not if we accept the doctrine that only existing accumulations of savings can be used to finance capital formation. How then was it possible in the 1960s to carry on a war in Vietnam and at the same time indulge in what seemed at the time and continues to be an orgy of over-, even grossly conspicuous consumption?

Consumer credit. During the 1960s the use of consumer credit spread rapidly among the middle class. According to the Wall Street Journal of March 12, 2010, per capita household debt is now in excess of $43,000. The buildup appears to have begun in 1950 with the first independent credit card company, Diners Club (now Diners Club International). Consumer credit had always been a serious problem, but it was one usually restricted to the lower economic classes. "Dollar-a-Day Slavery" on the installment plan had reached epidemic proportions by the first decade of the 20th century, as the numerous popular articles and scholarly studies on usury and loan sharking reveal.

In response, the cooperative banking movement gained a great deal of ground. A cooperative bank, of which credit unions are the most common surviving example, is organized to help the poor help themselves through small loans for consumption purposes. As a form of deposit bank, a cooperative bank cannot issue promissory notes (create money), and makes loans only to the extent of its deposits. Micro-lending on the model of Muhammad Yunus's Grameen Bank is a type of cooperative bank. Cooperative banking based on existing accumulations of savings reigned supreme in the first half of the 20th century until replaced by consumer credit cards based on the creation of new money.

Cooperative banking is thus a good use of credit, in the sense that accumulated savings represent unconsumed income. Making a loan out of existing savings for the purposes of consumption is simply putting the savings to proper use. A credit card, however, is a bad use of credit, for it creates money for the purchase of something that does not generate its own repayment. The money so created is not asset backed, but debt backed, relying on the borrower's ability to repay the loan of new money out of other sources of income. To illustrate this point, a brief description of one of the better and more innovative cooperative banking systems might help: the "Morris Plan."

In 1910, at a time when concern over usury and loan sharking was at its height, Norfolk, Virginia attorney Arthur J. Morris opened the Fidelity Savings and Trust Company. The "Morris Plan" was to make small loans to working people for consumption purposes. Fidelity Savings was funded with $20,000 provided by Morris and some associates. It and similar institutions were called "Industrial Banks" not because they financed industrial capital, but because their clientele was drawn primarily from the "industrial classes," i.e., factory workers, the "working poor." The idea spread rapidly, so that by the 1930s there were more than a hundred Morris Plan banks. The number declined after the 1930s when regular commercial banks began offering similar services, and many Morris Plan banks were acquired by or absorbed into established commercial banks.

Morris Plan banks had some unique features that contributed to their loan default rate of less than a tenth of one percent. Loan applicants had to submit references from two other individuals of similar character and earning power. These two people would guarantee the borrower's creditworthiness, and agree to repay the loan if the borrower defaulted. Interest rates were low, contributing to the success of the plan.

With the Studebaker Corporation of South Bend, Indiana, the Morris Plan Company of America (a holding company for Morris Plan banks) was an early innovator in automobile financing. Perhaps most significantly, the Morris Plan Insurance Society was established in 1917 to provide credit life insurance to repay a loan in case a borrower died before it could be repaid, with any amount in excess of the outstanding balance paid to the decedent's estate. This is the earliest use we have found of insurance as a substitute for traditional loan collateral.

As Arthur Morris explained his plan to some financiers who were considering establishing Morris Plan banks throughout the United States,

I told them simply that America's strength was in mass production and the only way to insure mass production was mass consumption. And, like night follows day, we can't have mass consumption without mass credit. And, what's more, mass credit guarantees mass employment. That got them! The only thing I left out, but since have learned was that mass credit would create a standard of living among Americans unequaled anywhere in the world.

Morris's analysis is consistent with that of Moulton, who proved that demand for capital derives from consumer demand. It is not the case, as Keynes asserted, that consumption must be reduced before new capital formation can be financed. As Moulton concluded,

We find no support whatever for the view that capital expansion and the extension of the roundabout process of production may be carried on for years at a time when consumption is declining. The growth of capital and the expansion of consumption are virtually concurrent phenomena. (The Formation of Capital, op. cit., 48.)

In other words, the Morris Plan and other forms of cooperative banking were oriented toward ensuring that existing savings were used not for reinvestment — that was not Morris's concern — but for consumption. This fit in perfectly with Adam Smith's dictum that the purpose of production is consumption, and with Moulton's application of the real bills doctrine to the problem of finding adequate financing for new capital formation when existing accumulations of savings are not sufficient to finance new capital (ibid., 104-106), and cutting consumption would undermine the feasibility of any new capital formed (ibid., 26-36).

Clearly, then, the "old" type of consumer credit (exemplified by the Morris Plan) differs substantially from the "new" type based largely on credit cards. Cooperative banking simply puts savings to their proper use, while credit cards create new money, shifting demand and transferring large amounts of purchasing power through inflation. The problem with both the old and the new style of consumer credit, however, is that it reveals a serious systemic weakness in the economy: the inability of workers to generate sufficient income through labor alone.

Kelso and Adler examined this problem in The Capitalist Manifesto in 1958. They also described a method that could be used that would allow ordinary people without existing accumulations of savings to gain access to capital credit. In a proposal similar to Arthur Morris's use of credit life insurance to collateralize consumer loans, Kelso and Adler advocated capital credit insurance and reinsurance to replace the demand for collateral on productive loans. (The Capitalist Manifesto, op. cit., 243-244.)

Kelso and Adler only touched briefly on the suggestion to use capital credit insurance and reinsurance to replace collateral in The Capitalist Manifesto. In 1961 they published a new book that went into the idea in much greater depth. While a much shorter work — almost an extended journal article — The New Capitalists may, in a sense, be more important than The Capitalist Manifesto, although it shares with the earlier work the use of the ambiguous terms capitalist and capitalism. Despite this presumed flaw, the significance of The New Capitalists is highlighted by its subtitle: "A Proposal to Free Economic Growth from the Slavery of Savings."

Citing Moulton's The Formation of Capital, the proposal detailed in The New Capitalists is to finance the acquisition of corporate equity by ordinary people without savings by using credit extended by commercial banks. According to Kelso and Adler (and substantiated by Moulton) this is how "the rich" have financed the vast amounts of capital they possess. The rich did not accumulate wealth by stealing "surplus value" from workers or consumers.

Instead, acquisition and financing of the new capital is accomplished by cooperating with the commercial banking system to create new money backed by liens on the new capital to be financed with the new money, and secured (collateralized) with accumulated savings, necessarily in the form of existing capital. This employs the concept of "financial feasibility." That is, no new capital is financed (especially with new money created in accordance with the real bills doctrine) until and unless there is a reasonable probability that the new capital will generate sufficient profits to meet the debt service payments and provide an adequate return to the investor. As Moulton explains,

When the managers of modern business corporations contemplate the expansion of capial goods they are forced to consider whether such capital will be profitable. They must begin to pay interest upon borrowed funds immediately and they must hold out the hope of relatively early dividends on stock investments. (The Formation of Capital, op. cit., 29.)

In order to break the stranglehold that doctrinaire reliance on existing accumulations of savings as collateral forces on the economy, Kelso and Adler advocated replacing traditional collateral with a capital credit insurance policy. The risk premium typically charged on all loans (except those made to the extremely risky federal government, which can print money to repay its creditors, thereby shifting the risk to taxpayers and consumers) would be used not by the commercial bank as self insurance, but as the premium on a new type of insurance: capital credit insurance.

For riskier loans, or too many loans of one type held by an insurance company, there should also be reinsurance, or insurance on the insurance. Thus, people without existing accumulations of savings would be able to obtain loans for productive purposes on the same terms as the rich, but with a greater degree of security and scrutiny. Further, the economy would no longer be bound by the artificial constraints imposed by reliance on the discredited production possibilities curve. This would promote full employment of all resources — including human labor. The Kelso proposal would achieve naturally what the Employment Act of 1946 attempted to do by manipulating the money supply and complicating the tax system by transforming what was intended to provide the State with sufficient revenue to carry out its job into a social engineering tool.

Kelso emphasized the full employment of all resources aspect of the plan in The New Capitalists by including a proposal for a "Full Production Act of 19—" in a book he published with Patricia Hetter a few years after The New Capitalists: Two-Factor Theory: The Economics of Reality (New York: Random House, 1967). In his "Explanatory Note" Kelso states,

The Full Production Act of 19—, although useful as a model for economic policy legislation based on two-factor theory . . . has been designed for illustrative purposes to replace the Employment Act of 1946. Since the latter act is generally recognized to be the most important economic policy legislation in the United States, the immediate question arises as to why it should be superseded.

The reason is this: the Employment Act of 1946 is bottomed on one-factor economic theory. It assumes that economic goods and services are produced only by labor, and that capital (the nonhuman factor of production) functions mysteriously to make labor more productive. This is what the "conventional economic wisdom" of our day holds to be true, but in fact, it is not true.

If the function of technology is to shift the burden of production from labor onto capital — that is, to substitute production by the nonhuman factor for human toil; and if the great bulk of our wealth is already produced by capital (rather than by labor), as our eyes tell us is the case, then full employment, even if attainable, is never enough. No household can reach its maximum economic productiveness, no matter how many members of it are employed, nor can it enjoy equality of opportunity for personal leisure and economic security, unless it also owns a viable capital estate. (Two-Factor Theory, op. cit., 167-168.)

The time was drawing closer to when a "prime mover" would recognize (at least in part) the revolutionary wisdom inherent in the Kelso ideas. Unfortunately, other factors were also operating that had — and continue to have — the potential both to inhibit or prevent effective implementation of the ideas, as well as provide another trigger that would bring the economy down in a crash far worse than that of 1929.

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