Simplified Exposition of Axiomatic Economics
Section IV: Money and Credit
The distinction between wealth and income is not just one of semantics. Most people define poverty to be low income, not a lack of wealth. It is unemployment figures, not asset figures, that are printed in the news media and it is national income that is maximized in IS-LM analysis. The logical conclusion of thinking in terms of a lack of jobs rather than a lack of wealth is either to put low income people on the government's payroll or to train them to work. In fact, this is what most people have in mind when they think of a jobs program, and their conclusion is supported by mainstream economics. Anyone who has heard of the multiplier (it is introduced in first semester macroeconomics) knows how mainstream economists think government spending affects national income.
However, I assert that welfare and make work programs are not a solution to poverty because they do not create wealth. People just spend their subsidy on immediate consumption and, a month later, they are still in poverty and need another welfare payment. This is an easy application of the Law of Price Adjustment for, if such government spending created wealth, it would have to do so by increasing the stock of those phenomena which the recipients spend their subsidy on. But this contradicts Theorem 13, that the stock at saturation remains constant in response to an increase in the importance of a phenomenon relative to money. However, it may not be clear that job training programs do not create wealth for, in a sense, job skills are as much a part of the capital stock as actual machines are. But job skills are not the most important part of the capital stock, primarily because they are so easy to acquire. Employers who ask for years of experience at relatively simple tasks do not accept training as a substitute. Their companies are expanding and they are hiring experienced personnel away from declining companies, which represents variance in an industry, not growth. Training people to operate certain machines does not work any more than welfare unless those machines are being manufactured; all of the machines currently in existence have operators. Training programs are actually an insult to people's intelligence because they could learn to operate virtually any machine within a matter of days. They know that the reason they are unemployed is not a lack of skills but simply because there are not enough machines to go around. In general, there is not enough capital.
The act of creating new capital, manufacturing new machines, is called investment. A government has two methods to pay for its consumption: It can tax people or it can sell bonds. Taxes are just confiscation and are taken entirely out of private investment. Bonds that mature in the hands of private parties (not the central bank) compete with corporate bonds. Because the buyers hold them to maturity, they are interested only in receiving interest and would buy corporate bonds if the treasury did not offer them a higher interest rate. Thus, the two forms of fiscal policy, taxing and borrowing from the public, either confiscate or crowd out an equal amount of private investment. Bonds sold to the central bank (either directly or to private dealers who pass them on to the central bank before maturity) are paid for with a check that the central bank writes against itself. The treasury then deposits this check in a commercial bank, allowing commercial banks to buy government bonds amounting to several times the amount that the central bank bought. (The exact multiple is determined by the reserve requirement.) Thus, the two forms of monetary policy, selling bonds to the central bank and to commercial banks, are effectively just printing money and using it to buy capital away from private investors. Capital consumed by a government through fiscal and monetary policies was never idle but would otherwise have gone to the creation of wealth. Common sense alone is sufficient to verify such an obvious assertion.
The use of credit money (bills of debt) is an alternative to using money certificates and thus a negative influence on their value. It is sometimes thought that, if the issue of money certificates, which is also a negative influence because it increases their quantity, is used only to eliminate the first negative influence, the value of money remains stable. Thus, the argument continues, if a central bank refrains from issuing money certificates except to buy bills of debt which are then held until they mature, the quantity of fiduciary money in circulation is made directly proportional to the quantity of credit money removed from circulation, leaving the stock of money in the broader sense unchanged. This would work if it were not for the fact that the quantity of credit instruments removed from circulation (sold to a bank) is itself a function of the quantity of fiduciary money issued by the bank. When a person writes an IOU for phenomena received, it has a face value greater than the present price of that phenomenon or the seller would demand immediate payment. If the seller of that phenomenon is unable to wait for the IOU to mature, however, he can sell it to a bank at a discount of its face value, thus receiving only what he would if he demanded immediate payment for his phenomena. Because of his weakness and the bank's relative strength when it comes to the ability to wait for an investment to be realized, the bank collects interest on that IOU. This strength of a bank's, like anyone else's, is a function of its wealth. However, because a central bank has the ability to arbitrarily increase its wealth with fiduciary money, it has a disproportionate advantage. This allows it to buy credit instruments at very close to their face value even when they still have some time to mature. This practice greatly increases the demand for credit instruments instead of immediate payment because people know that they can sell them to a bank. Thus, credit instruments are sold to a bank that were never really a part of credit money as they were never exchanged from person to person, which would have decreased the need for money certificates, but were sold to the bank immediately upon being written. Existence alone is not a sufficient condition for credit instruments to be included in the stock of money; there must be an active secondary market for them in the community.
Thus, the institution of central banks is built on a deception. By assuming that all short-term credit instruments function as money, they can issue money certificates while claiming to leave the stock of money in the broader sense unchanged. If they operated like counterfeiters and just printed money and then went out into the world to spend it, they would receive little support from the people. Instead, they accomplish the same thing but in such a circuitous manner that they receive only confusion from the people. The treasury issues bonds which may be purchased by anybody but are mostly purchased by private dealers. Most of these are resold to the central bank. The check it writes is deposited at a commercial bank where it is highly valued because it counts in the reserve requirement that commercial banks must keep to back up their own checking accounts. Cash also counts, but the checks of other commercial banks do not. The reserve requirement is about 12.5% and, while the bank which receives a check from the central bank cannot itself write eight times that amount in checks, by a process explained in Axiomatic Theory of Economics, the amount of checks written by all commercial banks will increase by eight times the amount of the central bank’s purchase of government bonds. The commercial banks can spend this new found money on anything they want, though they are encouraged to spend it on government bonds. Without a vast and bloated bureaucracy to watch over them, however, it is difficult to prevent the banks (including savings and loans) from spending it on get-rich-quick schemes which, if successful, bring great profits to the bankers and, if unsuccessful, dump great losses on the taxpayers. The term “national debt” refers to the government bonds sold mostly to the central bank, some to commercial banks, and almost none to private savers. Since the central bank and the treasury are both branches of the government, they have effectively just printed some money and spent it. The word "debt" is used only to obscure the process and does not have any meaning in this context. One possible exception is countries with a large trade deficit. This implies that foreigners own some of their assets and, while they usually prefer real estate and businesses, they may take government bonds.
To attack the root cause of unemployment, the government must be prevented from wasting the capital of the nation. Piecemeal elimination of obvious boondoggles is a move in the right direction. However, because of the vested interest in each boondoggle, the system of pork barrel politics is quite stable. It is more effective to reduce the government's revenue and leave Congress alone to spend what they get than it is to attempt to influence specific legislation. Revenue from taxes has a natural limit: People individually evade taxes that they consider to be unfair and collectively vote against legislators who support unreasonable tax bills. Tax revenues are responsive to genuine emergencies such as an invasion, however, so they may be considered the measure of how much government people want. To reduce the revenue of a government down to what people are willing to pay in taxes (or patriotically purchase in bonds), the central bank must be eliminated. In the United States, the central bank is the Federal Reserve. If it can be shown to be unstable, then decentralization of the banking industry is possible.
Decentralization is not the same thing as deregulation. The term "regulation" is meaningless without reference to the basic framework in which banks operate. A stable system can be governed by the usual laws against criminality that apply to all businesses, while an unstable system requires a vast regulatory bureaucracy and is still plagued with corruption. It is naïve for people who dislike big government to advocate deregulation in the latter case, but it is also wrong to assume that the existence of a central bank is part of the regulations which attempt to prevent corruption. Central banks and regulatory bureaucracies are associated with one another, not because they both oppose an inherent instability in banking, but because the existence of a central bank creates an unstable system that requires constant policing.
The theory of economics presented in Axiomatic Theory of Economics is divided into two chapters and they each have a point. The point of the first chapter is the Law of Price Adjustment. The point of the second chapter is that the purpose of monopolizing the right to issue money is to cheapen it. If every bank issued its own money, none of them could cheapen it for fear of losing reserves to competing banks and the system would be perfectly stable. A central bank does not provide stability because, having eliminated its competition, it need not fear losing reserves due to imprudent management. In fact, without massive regulation, it causes just the kind of corruption that was seen in the United States' recent, misguided attempt at deregulation. The purpose of the Federal Reserve is not now and never has been to create stability. Its purpose is to provide the government with a convenient method to siphon off the wealth of the nation. A decentralized system does not do this because, without a central bank standing ready to fill the treasury, it is unlikely that private banks would consider the government a good enough risk to grant it credit. At least they would not grant the government unlimited credit, which is what the Federal Reserve was designed to do.
Eliminating the Federal Reserve is more efficient than requiring that the government balance its budget. Balancing the budget is an accounting trick and to talk about a budget while a central bank exists is, quite frankly, missing the point. That would be like successfully besieging a city and then telling one's soldiers to be sure that they pay for anything they take from the people's homes and shops. The soldiers would think that their general was mad. The purpose of besieging a city is to loot it and the purpose of a central bank is to run deficits. And the national debt, lest anyone misunderstand, is all that the government has consumed without the consent of taxpayers.