ECONOMICS & MONEY
An alternative model of development, the new paradigm of binary economics
Norman Kurland, lawyer, economist
22 March 2016
What is money? In his 1967 book coauthored with his wife Patricia Hetter Kelso, Two-Factor Theory: The Economics of Reality, the late Louis O. Kelso described money:
Money is not a part of the visible sector of the economy; people do not consume money. Money is not a physical factor of production, but rather a yardstick for measuring economic input, economic outtake and the relative values of the real goods and services of the economic world. Money provides a method of measuring obligations, rights, powers and privileges. It provides a means whereby certain individuals can accumulate claims against others, or against the economy as a whole, or against many economies. It is a system of symbols that many economists substitute for the visible sector and its productive enterprises, goods and services, thereby losing sight of the fact that a monetary system is a part only of the invisible sector of the economy, and that its adequacy can only be measured by its effect upon the visible sector.
What is clear from this description is that money is a “social good,” an artifact of civilization invented to facilitate economic transactions for the common good. Like any other human tool or technology, this societal tool can be used justly or unjustly. It can be used by those who control it to suppress the natural creativity of the many, or it can be used to achieve economic liberation and prosperity for all affected by the money economy.
How important is money? Meyer Amschel Rothschild, the founding father of one of the world’s most powerful financial dynasties, has been quoted, perhaps apocryphally, as having said:
Let me issue and control a nation’s money and I care not who writes the laws.
Such a statement is a reaffirmation of the clear-sighted eighteenth century political insight of Benjamin Watkins Leigh, in the Virginia Convention, who observed:
Power and Property can be separated for a time by force or fraudbut divorced, never. For as soon as the pang of separation is felt, Property will purchase Power, or Power will take over Property.
It takes no genius to understand the relationship between money and market prices. Too many dollars chasing too few goods is the classic definition of inflation. And history is replete with cases where money has been politically controlled in ways that benefit only the few at the expense of the many.
In this article a case will be made for a major transformation of any nation’s monetary system so that in the future new money will be created in ways that would unharness the full productive potential of society, while closing what The Wall Street Journal recognizes as the growing wealth gap between the richest 10% and the rest of society – and to do so voluntarily without the need to redistribute existing wealth. Prices, wages and interest rates would be controlled under the proposed model of development completely by competitive market forces, not by the whim of central bankers, politicians or organized power blocs.
This article will aim at showing that Say’s Law of Markets–that supply can create its own demand and demand its own supply–can be made to work if capital credit is universally accessible to all. This new paradigm, first developed by Louis O. Kelso and later refined by Robert Ashford and Rodney Shakespeare, would result in an asset-backed money supply that would provide sufficient liquidity to banks and other financial institutions for financing all or most of the new productive assets which are added each year to grow the economy.
While this author recognizes that both Karl Marx and John Maynard Keynes, and their many followers in academia, have rejected Say’s Law of Markets, this paper will point out how the binary economic model originally conceived by Louis Kelso refutes the criticisms of Marx and Keynes and offers a more sound moral and economic framework for promoting sustainable development within a market system. The Kelso model–recognizing both labor and capital as direct and interdependent sources of mass purchasing power–would be structured to create a more just and more productive system than any market system in the history of modern civilisation.
Wealth distribution assumes wealth creation, and productive capital (i.e., technological and systems advances and improved land uses), according to recent studies, accounts for almost 90% of productivity growth in the modern world. Thus, balanced growth in a market economy depends on incomes distributed through widespread individual ownership of productive capital, all nonhuman means of production. The technological sources of production growth would then be automatically linked by free market forces with the ownership-based consumption incomes needed to purchase new wealth from the market. Thus, Say’s Law of Markets–which both Marx and Keynes attempted to refute–would become a practical reality for the first time since the Industrial Revolution began.
The challenge this article will present, especially to academic economists, is to demonstrate mathematically how Say’s Law of Markets can be reconciled both with the classical quantity theory of money and various measures of net national product (NNP) to permit accelerated rates of growth without inflation.
A side-effect of this proof is to relegate the Phillips’ curve–that inflation and unemployment are inextricably linked–to the dustbin of economic history. The ultimate aim of this paper is to present a logical and unified market system that is structured to combine economic efficiency with fundamental principles of economic justice. Implicit in this position is that no known economy in the history of civilization, particularly since the advent of modern technology, has offered both genuine justice for all, and optimum rates of productive efficiency. If this author is correct, those frustrated by today’s unfree and unjust market economies are urged to come together for serious study and discussion of an alternative model of development, the new paradigm of binary economics.
“Without the broad ownership program for all of citizens, all newly created capital would flow automatically into a relatively stationary ownership base, as it has since the beginning of the Industrial Revolution.”
Image – Public Doman
Problems Not Effectively Addressed by Conventional Economics
How will the U.S. economy finance the $2 trillion required each year (at 2000 rates of growth)8 to meet the nondefense capital requirements of the U.S. private and public sectors in the form of new plant and equipment, new hardware and software technologies, new rentable space and new physical infrastructure?
Assuming we can solve this problem, who will own the massive amounts of new capital brought into existence to meet our needs for energy self-sufficiency, new communities, and new housing, mass transit, new communications systems, resource recycling and conservation, expanded food and fiber production, etc.? Will those assets be owned by the same top 10% of U.S. families who own and control 90% of directly owned U.S. corporate stock? Will those assets be owned by government and quasi-government agencies? Will those assets, in the words of Peter Drucker, be “socialized” in the hands of money managers, pension funds or foundation bureaucrats? Or will that new capital become owned by many people whose incomes today depend almost exclusively on their (often subsidized) jobs, paternalistic government welfare and subsidy handouts, and private charity?
Can such massive investments be made without foreign oil dollars, or, for that matter, without exclusive dependency on the past savings accumulated by the rich or the reservoirs of accumulated small savings of the middle class and the poor? Can capital be acquired on expanded bank credit (“pure credit”) secured by the future income (or future savings) derived from such new investments?
Can the Federal Reserve System become the “lender of last resort” so that the “full faith and credit” of “We, the People” can pump newly issued money into the banking system on a self- liquidating and asset-backed basis? And can this newly created credit be channeled under the supervision of local banks into unsubsidized, self-liquidating, commercially insured loans at 2- 4% borrowing costs to fund feasible projects of enterprises that voluntarily want to acquire their future capital needs in ways that broaden the base of U.S. capital ownership in the process?
Why is the Asset Gap Growing Between A Wealthy Elite and Other Citizens?
What explains the growing maldistribution of capital ownership in America and throughout the global economy? Why is there a massive and growing capital gap between the already wealthy and those who have little or no capital assets and generally live from hand to mouth? Why is it easier for a Bill Gates to increase his capital from $10 billion to over $90 billion in a few years than for the average American to accumulate in net worth enough to live on for two or three months?
Let us examine some of the structural root causes that enable the rich to get richer and the poor to become increasingly vulnerable to the forces of global change. Wealthy people can attract capital credit (i.e., other people’s money) to add new and more powerful productive assets to their existing ownership stakes, because wealthy people can pledge their previous accumulations as collateral, thus eliminating the potential risk to lenders in the event that the loan cannot be repaid. Most citizens, especially the poor, have no assets to pledge as collateral. Therefore, most people cannot qualify for capital credit to purchase, on the same terms as the already wealthy, newly added self-liquidating productive assets. Once feasibility standards are met, such assets, in the hands of reasonably competent management, will pay for themselves out of future profits or savings and then become a source of additional capital incomes for those with access to capital credit. Thus, those without assets (and therefore by definition people who cannot overcome the traditional collateralization hurdle) remain with little or no hope to share profits from their own assets and gain an independent source for their future consumption incomes.
“Virtually none of the newly created capital is financed in ways that create any new owners when it is formed. Those without assets remain with little or no hope to share profits from their own assets and gain an independent source for their future consumption incomes.”
The Logic of Corporate Finance: A Key Tool for Creating New Owners Simultaneously with New Capital Creation Within a Market Economy
The guiding logic of all corporate finance is that all projects must be self-liquidating. Newly formed capital, such as improved land, new structures and new tools, are never brought into existence by a well-managed enterprise unless the new investments will pay for themselves. Under ordinary circumstances, “payback” for new equipment is generally expected within three to five years. In the corporate sector, it is interesting to note, the corporate umbrella insulates the eventual owners of this new capital, generally the already wealthy, from personal risk in the event the corporation defaults on its loans or goes bankrupt.
Using conventional methods of finance, over $2 trillion of new productive assets (or about $7,500 worth for every man, woman and child) are added annually to both the private sector and public sector of the U.S. economy. Virtually none of this newly created capital is financed in ways that create any new owners when it is formed. Theoretically, all or at least most of these assets could be financed in ways that they could be broadly and privately owned, as suggested by Louis Kelso and other binary economists since the 1950s.
Binary economics would require that inclusionary self-liquidating capital credit be made accessible to corporate employees and other current non-owners of productive capital in order to turn them into economically independent capital owners. And, in the same way that the currently wealthy use credit to increase their wealth, and thus their incomes, this would be done without unreasonable self-deprivation during the working lives of people economically enfranchised under a comprehensive national expanded ownership strategy.
As the logic and techniques of binary corporate finance are extended throughout the economy, all new incremental productive power can automatically be built into individuals who have unsatisfied needs and wants–without diminishing their take-home pay or past accumulation of savings. This will break the monopoly of capital ownership held by the currently wealthy–those with functionally excessive productive power in terms of their consumer needs and wants. The savings of the currently wealthy would then flow into the most risky and speculative ventures, or for insuring capital credit for the non-rich, or for supplying consumer credit and other nonproductive forms of credit.
“Pure credit” can be defined as productive credit extended by a commercial bank, other financial institutions or a central bank in a manner independent of past savings, so that the amount borrowed plus all transaction costs are secured and repayable with future savings from the capital assets acquired with such credit. Limiting the extension of “pure credit” by the central bank to current non-owners and leaving the pool of past savings open for use by the currently wealthy and for nonproductive government and consumer borrowing would result in a noninflationary expansion of the ownership of capital assets. Such high-powered credit would enable private lenders to expand the money supply for feasible private sector projects by discounting their “eligible” asset acquisition loan paper with the central bank. This expansion of the money supply could continue as long as underutilized resources, people and technology are available for supplying more marketable goods and services to the economy. “Pure credit” would thus free the economy to grow to the full physical limits of its workforce, available resources, technology, and the projected additional buying power of new domestic and foreign consumers.
After each increment of new capital has paid for itself from the future earnings (future savings) that it produces, effective demand and effective supply would be synchronized by normal market forces–and this would continue to do so as long as the new capital became a source of an expanded income for the poor and those in the middle-class who today do not have adequate and secure incomes to meet their needs. Binary economics would enable them to produce and earn more as owners of “procreative” capital in order to meet these needs.
From the standpoint of corporate productiveness, the binary economics approach would build all increases in capital productiveness (i.e., value added by capital assets) into workers and other non-owners. New owners would then be entitled to all the income increases attributable to their growing shares of corporate ownership. Artificial pressures for increases in labor and welfare incomes that add to costs and therefore go into the price of products sold (e.g., more pay for less work) would tend to diminish. Removing artificial restraints on capital creation would enable output to soar.
Once the cost of creating such capital is liquidated and the new money is cancelled out, the productive assets continue to produce wealth and incomes for its owners many times their original formation cost. Hence, where capital incomes are distributed broadly within a nation of owners, prices can eventually be reduced, while making the economy as a whole work more efficiently and equitably.
“Kelso’s binary economic system and the social technologies that would become available under the Capital Homestead Act offer a new route to accelerated, quality growth without inflation in the modern economy.”
Image Public Domain
A Two-Tiered Interest Solution for Separating Good From Bad Uses of Credit
Should the Federal Reserve establish a two-tiered interest structure that sharply differentiates between participatory and productive uses of credit and exclusionary and/or nonproductive uses of credit? Under such a system, the first or higher tier, as at present, would be based on market- determined yields on already accumulated savings available to the economy (“old money”).
Interest rates on old money would contain whatever “inflation premium” is appropriate to offset the direct and indirect inflationary effects of present monetary, fiscal, employment and income maintenance policies. The lower tier would be based upon “new money” created exclusively for financing private sector capital expansion in ways that democratize access to future capital ownership and profits, a counter-inflationary process the Center for Economic and Social Justice calls “Capital Homesteading.” Capital Homesteading would provide all citizens with on self-liquidating capital credit to purchase new and transferred capital secured by future profits of viable enterprises.The lower tier of expanded bank credit for Capital Homesteading projects would be grounded on a Federal Reserve discount rate or “service fee” of 0.5% or so to cover all central banking costs.
The markup above each bank’s cost of money (estimated at 2 to 4% for low-risk capital credit) would be market-driven, based wholly on:
(1) the risk of loan default (the “risk premium”),
(2) the cost of administering the loan, and
(3) a reasonable profit for the lending institution in competition with other lenders.
Capital Homesteading: A New Vision for the New Millennium
Following the precedent established for decentralizing land ownership under the homestead acts of the 1860s, the nation should now adopt a Capital Homestead Act to share in a totally voluntary way the ever-expanding capital frontier resulting from the continuing advances of modern labor-saving technology. Under Capital Homesteading as a basic pillar of economic policy, the focus of politics will shift to the monetary, banking, insurance, tax and inheritance law reforms needed to create a nation where capital ownership is as accessible to every citizen as the political ballot. As such, the focus would be concentrated on dismantling legal and institutional barriers to more equal ownership opportunities.
All or a major portion of the $2 trillion of the annual “growth ring” of U.S. productive capital can and should be financed through loans made to Treasury-qualified, tax-exempt Employee Stock Ownership Plan (ESOP) trusts and similar Capital Homesteading vehicles and secured by future enterprise profits. These other vehicles for democratizing access to capital credit would include Individual Stock Ownership Plans (ISOPs) to enable all American citizens and families to invest in a diversified portfolio of newly issued shares in well-managed and economically viable new and expanding enterprises, Community Investment Corporations (CICs) for putting ownership and control over local land in the hands of local citizens and Consumer Stock Ownership Plans (CSOPs) for spreading ownership of natural monopolies among regular customers.
An alternative approach to democratizing the capital credit needs of the U.S. economy is to enable every citizen to establish a Capital Homestead Account or “CHA” (a variation of the ISOP concept) at his or her local bank to receive direct personal access to capital credit as a fundamental right of citizenship. By putting more personal choice in the hands of new owners, their governance rights would likely be enhanced over top-down approaches to Capital Homesteading. With access to monetized credit through a CHA, each citizen from birth would have the funds to invest, with the help of an investment advisor, in full dividend payout shares of 1) the company that he or a member of the family works for, directly or through an ESOP, 2) the companies he regularly buys from, directly or through a CSOP, 3) a community investment corporation to link him to profits from and control over local land development, and 4) a variety of blue-chip growth companies with a history of profits. Capital incomes earned from dividends on one’s CHA account offer a private sector supplement to prevent bankruptcy of the pay-as- you-go Social Security system. Under conservative projections, a citizen could accumulate from birth to retirement a tax-sheltered estate of $200,000. Furthermore, over that period, he would receive dividend income totaling over $750,000, and at retirement an estimated annual CHA dividend income of $30,000.
If lack of collateral is one of the major barriers to closing the wealth gap between the rich and the poor through the democratization of capital credit how can this collateralization barrier be overcome?
A substitute is needed for the collateral generally required by lenders to cover the risk of default. That substitute would be a system of credit insurance and reinsurance.
Lenders making “qualified” loans could either self-insure or pool the “risk premium” portion of debt service payments by insuring with commercial capital credit insurers against the risk of default, perhaps 80% to 90% of the unpaid balance. To spread further the risk of loan default, these commercial insurers could come together to establish a Capital Credit Reinsurance Corporation (“CCRC”). Some of the CCRC’s reserves could be provided in the form of investments by the already wealthy. Or a portion of the reserves could be provided by the Federal, state or local governments, but only if the CCRC is structured to avoid the unlimited liability that taxpayers were exposed to by making the Federal Government “the insurer of last resort” of failing savings and loan banks in the 1980s.
To further support the CHA, a National Capital Credit Corporation (NCCC) could be set up, similar to Fannie Mae and Freddie Mac, to package and set national standards for insured, self- liquidating capital loans and then discount these loans at the discount window of one of the 12 regional Federal Reserve banks. The Federal Reserve would treat insured CHA loan paper like government debt paper as substitute backing for the U.S. currency.
Legislative Reforms to Create A More Just Market Economy
After hearings devoted to careful scrutiny of Kelsonian concepts and program reforms,12 the Senate and House Banking Committees should enact legislation designed to:
(1) Establish a public or quasi-public Capital Credit Reinsurance Corporation (or encourage private insurance companies to perform this function) to insure banks, insurance companies, and other lenders who make loan financing to Employee Stock Ownership Plan (ESOP) Trusts and similar credit mechanisms, such as the ISOP, CSOP and CIC. (This would be similar to the way the Federal Housing Agency insures mortgages on home financing but without making the government the insurer of last resort.)
(2) Amend Section 13 of the Federal Reserve Act to mandate that the Federal Reserve Board and Federal Reserve Banks increase the money supply responsively in ways that enable banks and other qualified lenders to make “qualified” Capital Homesteading loans on feasible (i.e., self-liquidating) projects by discounting the loan paper at a discount rate reflecting real Fed costs (i.e., “pure credit” rates that exclude any inflation premium), pursuant to regulations to be adopted by the Federal Reserve System. The Fed might also require as a condition of eligibility that such loans be insured by capital credit insurers and, for more security, that the insurers pool their risks with a capital credit reinsurance facility.
(3) Establish a counterpart of Fannie Mae and Freddie Mac to set national lending standards and insurance criteria for Capital Homesteading loans, with the power to package loans made by qualified financial institutions for discounting with the Federal Reserve System.
(4) Remove the power that the Federal Reserve now has to change directly the quantity of money in circulation through purchase and sale of government securities via the Open Market Committee, thus preventing future monetization of government deficits and forcing government into the competitive market to fund government debt. It should be noted that the new money added for Capital Homesteading would substitute dollar-for- dollar with the reduction in open market purchases of government debt paper.
(5) Eliminate the power of the Federal Reserve to control growth of the economy by raising and lowering interest rates, thereby allowing all interest costs above the lender’s “cost of money” under the two-tiered interest rate system to be set entirely by competitive market forces.
In effect, these new policies would amount to launching and promoting a counter-inflationary alternative to today’s exclusionary and wealth-concentrating monetary policy. With new consumer power linked directly to the productiveness of new productive assets, the economy would grow at the full extent of its human and nonhuman capacity instead of being artificially constrained by the Federal Reserve System.
In contrast to conventional investment finance, which has systematically perpetuated monopolistic access to the ownership of new productive capital while limiting the economic participation of 95% of U.S. households to their technologically vulnerable labor inputs, ESOP and other Capital Homesteading financing technologies provide a more rational alternative for raising the consumer power of American workers on a direct and individual basis, without violating the overall economy’s laws of supply and demand and as a trade-off to unjustified wage increases or perpetual income transfer schemes.
Norman G. Kurland – Economist and Lawyer. A Founder and President of Centre for Economic and Social Justice.
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