Capital as Money

By Colin McGrath (with comments from Brian McGrath)


Imagine the next time you buy something, pulling out a piece of plastic and purchasing your item in the exactly the same way you would now use a credit or debit card.  But in this case, there is an important difference. Now you are purchasing with a transfer of shares of a broad capital index fund instead of traditional dollars.  For simplicity, suppose you and the seller are using the most familiar and widely held stock market capital index fund—SPYDRS (based upon the value of the 500 largest publicly held U.S. companies).  Hence, you would be trading a small piece of these companies to the seller in order to accomplish your purchase instead of using dollars.  There would be a small, agreed upon transfer out of your SPYDR account into the SPYDR account of the seller for whatever good or service you bought.  If this kind of transaction became widespread it would redefine what we think of as “money” and would change the nature of trading, prices, and wealth holding.  It would be simple but it would be revolutionary.  It would result in a privatized, non-bank transparent monetary and exchange system free of government manipulation, control and exploitation and free of the intrinsic instabilities of a currently broken fractional-reserve banking system.  How could it happen?













Imagine further a forward-looking discount brokerage firm that allows you to open a SPYDR equity account with trading privileges and then gives a trading SPYDR debit card to facilitate transactions.  Obviously, your purchases could not exceed the balance of your SPYDR account, unless the brokerage firm was willing to extend a short-term SPYDR loan to you.  Why would a brokerage firm be willing to facilitate such purchase transactions with essentially a SPYDR debit card?  Simply because it could get a small fee from every such transaction.  Moreover, if the practice grows, who knows where it might end.  Hopefully, SPYDRs could grow to become the effective money supply of the whole U.S. economy and why not?  Instead of using fictitious value of a government fiat money, or a speculative commodity money of little actual value in production, or an artificially scarce but intrinsically worthless cyber-money such as bitcoins, we would be using the most fundamental and valuable good of a market economy—ownership of a portion of the economy’s capital stock, the means of producing all goods and services.  The business opportunity for any brokerage firm accommodating changes in ownership and custody of even a small fraction of such exchanges could be staggering.

Who would win from such a trading system?  Clearly buyers and sellers or users.  Instead of risking the erosion of value in fiat money (inflation) they would be using, as money, an asset that currently gains in value 6 to 7 percent a year in terms of purchasing power over consumption goods.  Think about it.  At worst, even if you just lazily accumulated balances of such a monetary good as SPYDRs, instead of using them just for exchange, you would just be steadily growing the value of your wealth over time.  That is, exactly what you would be well-advised to hold in your IRA in any case.  Brokerage firms would also be winners.  By facilitating such exchange and providing custody for capital “money,” they would hugely expand the demand and holding of such assets and get a fee for every transaction they facilitated.  Of course, the competition would be severe and the fees for such SPYDR exchanges would be expected to be driven to a very small fraction of what trading fees currently are, in fact logically driven by competition toward zero per exchange.  They might only be applied by the purchaser’s brokerage firm because the seller’s firm would simply be gathering new assets.  Just for attracting the scale of new assets and trading activity, a competitive brokerage firm could easily see its way to making exchanges from such SPYDR trading accounts costless to customers as a part of its larger profit-maximizing strategy.  As the volume of capital-based exchange increased and became dominant, fiat money (dollars) would be an asset few people would chose to hold or accept in trade—thus the Federal Reserve Bank and the Government that covertly finances its purchases by printing worthless currency could be a loser.  However, if being a government of (and taxing) a more prosperous, larger and more stable economy is worth something, then even the government could be a long-term winner from moving to capital as money.

This last point is worth expanding on just a bit.  One of the most peculiar taxes imposed upon us is the so-called “capital gains” tax.  It is a tax imposed on property and assets, including capital, that gain in value measured in a fiat currency such as dollars between the time they are purchased and sold.  Of all taxes it is a particularly malicious, destructive, and dishonest tax.  Observers have noted that, in a society in which the government imposes a capital gains tax, all affected private property will gradually and inexorably be owned by the government, or at least given out as rewards to those who vote for it.  It is an amazing scam that the government imposes this tax in a way that gets us coming and going.  First the government imposes a tax based upon a supposed “gain” in value of a good or asset that we own measured in terms of a unit of fiat money and then, of course, it controls the supply of fiat currency.  Thus, if it feels it is not collecting enough capital gains taxes, it can simply inflate the currency generating a huge crop of fictitious and arbitrary capital gains.  Clearly it makes no logical sense to have a capital gain in money itself.  Thus, if capital becomes money, the fallacy of using the value of capital to measure capital gains or losses in other goods will immediately be made to appear a fallacious a concept as it actually is.

Any broad capital index could be used as the economy’s benchmark of value and medium of exchange.  Why do we suggest SPYDRs?  Simply because the S&P 500, while it doesn’t include all publicly traded companies, does account for about 95% of the total value of publicly owned stocks in the U.S.  That’s enough to be a pretty good representation of the broad capital market.  Moreover, at a time when the general public’s direct and indirect ownership of stock is widely considered to be too narrow (in the range of about 40%) limiting the wealth-enhancing return benefits of equity ownership to too few, what better way to broaden stock ownership than using capital as money—especially in an economy in which capital is increasingly replacing labor in production of goods and services.  As the ownership of capital is enlarged and broadened, aggregate investment in the U.S. economy will increase.  In the process the marginal return to capital will gradually fall toward the sustained growth rate of the economy, but as it does wealth will hugely increase due to capital price appreciation.  To see why, revisit Chapter Five in our book, Capital as Money.

To those who are fearful of using capital as money when the capital market is so volatile, we offer the following argument.  Remember that currently the market value of capital is measured in a fictitious and volatile fiat currency (dollars) which always carries inflation risk.  Beyond this, the dollar valued marginal product stream expected to be earned by capital is reduced to a present value (stock price) by using a fictitious government/Fed-determined government bond interest rate that is manipulated by central bank policy.  If the resulting value of capital were not volatile under this hare-brained scheme, it would be amazing.  Now imagine that instead of dollars and fed determined interest rates, the broad real marginal product of average capital itself was the fundamental or benchmark rate of return, against which all others were measured.  In such a world, the value of capital would probably not be volatile at all.

In fact, the real market-determined values of capital and consumption, at the margin, would determine the level of new capital good creation (investment) and the relative value of consumption goods versus capital goods as investors rationally pursue the consumption/investment trade-off that maximizes their expected long-term consumption path.  Then the benchmark basic real rate of return that markets keep their eye on would not be some fictitious so-called “risk-free” rate of return on government bonds stated in fiat currency, but rather the real rate of return to investment or capital on average which would converge to the long-term rate of growth of the economy.  The continuous comparison of whether to consume or invest at the margin (or consume now versus consume later) is exactly the genius of a free market at work.  In such a transparent world, the price of output used for consumption versus the price of output used for investment or new capital would logically discipline each price, driving them toward equality.  Serious or sustained overvaluation of either capital or consumption goods would be unlikely.  As a result, the volatility of the value of consumption or capital expressed in terms of the other would be low.

If our economy transitions to using the exchange of broad capital shares as money, then it can be imagined that at first everything will still be valued in the fiat currency—dollars.  This is, of course, what traders are familiar with.  Trades and values of goods and shares will doubtless be stated in dollars.  However, as the economy becomes more familiar with trading units of index shares for goods and services, this intermediate, unnecessary step will tend to disappear and prices and will tend to be more economically stated directly in terms of units of capital.

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A recent glance at U.S. monetary data is astounding.  The money base (that is high-powered currency issued by the Fed and held by individuals and banks) stood, at year’s end, at approximately $3.6 trillion.  The M1 money supply (currency held by the public plus checking accounts – the normal “transactions” of money) by comparison was much smaller, standing at $2.6 trillion.  This strange twist is not new, it has persisted since the 2008 credit collapse and it shows how badly broken our traditional banking system was and how hobbled it remains.  The world has moved on, but apparently our anachronistic money and banking system has not.  When the monetary system is “normal,” M1 is usually much larger than the money base.  That is the case when the banks are lending out all or most of their excess reserves as a growing pyramid of loans, creating new money balances in the process through the expansion of checking accounts.  This is what has traditionally been referred to as the “banking multiplier” portion of the stock of money.   It is this old, nasty characteristic of the “fractional-reserve” banking system that has historically resulted in a large injection of uncertainty and instability into our financial system.  It is the reason that past Federal Reserve chairmen have bemoaned the uncertainty and difficulty of controlling the overall money supply and hitting monetary targets.  It is destabilizing because it joins bank lending and monetary expansion at the hip, resulting in the central bank’s lack of control over the total money supply.  This “fractional reserve” banking characteristic is responsible for a sad history of credit booms and busts, of periods of inflation and deflation.

13106574_mThus a minor and unheralded blessing of our current situation is that the “normal” bank expansion of the money supply is not working now.  Why?  Because private banks are in the aggregate either too scared or too tightly regulated to lend—or both.  They are appear to be huddled down and cautiously accumulating all the excess reserves they can get.  This has been the case now for a number of years as the Fed has been desperately throwing high-powered money at the banking system without much effect on aggregate bank lending, “quantitative easings” 1, 2, 3, and so on.  Be thankful the traditional bank multiplier is not working.  If it was, inflation would now be roaring.   To the observer, the Fed is reminiscent of a peculiarly dull child who is flooding a campfire with more and more gasoline, evidently unaware that the embers are totally dead.  Nonetheless splashing about in gasoline is a dismaying behavior to behold.  Clearly it is fraught with danger, as any small spark could and would trigger a real conflagration with all the puddles of gas lying about.

Yet there is hope even for the very slow-witted.  In the back of the child’s mind there is somewhere the vague realization that more and more gas might not be a good thing.  The Fed has the same realization.  Somewhere in the recesses of their minds even central bankers are uneasily aware that flooding the economy with liquidity can somehow raise the risk of future inflation.  Didn’t they read it somewhere?  Thus, they embark on the “taper.”

Since bank lending has failed the strongest attempts by the Federal Reserve to re-ignite it for a number of years, why don’t we congratulate ourselves and just live without it.  The economy is evidently functioning and lending is occurring through other mechanisms—it is just that private banks and their lending are evidently playing a far reduced role.  A market economy evolves and moves on as new lending mechanisms arise as old ones diminish or fail.   The idea of linking bank lending activity to the growth of the overall money supply was always a crazy, de-stabilizing Ponzi scheme in any case—attractive mainly to bankers.  Good riddance to it.  The Fed should take this opportunity to quietly enact several new years’ resolutions for its one hundred and first year.  First and most importantly, set the bank minimum reserve requirement at 100%.  Given where the money and banking system is right now it would be a moot point with little aggregate effect.  For the future it would help make the monetary system more rational and stable.  For the first time in its history, the Fed would actually have a chance to precisely target and control the supply of money.

What should the central bank do next?  We could think of a couple of suggestions.  Follow a “rule of one.”  What do we mean by that?  To simplify the money supply process that Fed should get out of the role of manipulating monetary policy and simply issue “one” of something.  For example, one dollar (in other words divide all wages, prices, and monetary quantities by approximately 1/H or 1/$3.6trillion).  This could be a monetary policy that is understandable to all and possible to implement.  Even the most intellectually challenged central banker should be able to get their arms around the idea that the size of the U.S. money supply is pegged at just one dollar.  After all, with a fiat money units don’t matter, but keeping the supply stable and predictable does.

After the Fed realized that, with its “rule of one,” it really wasn’t doing anything in terms of monetary policy, it could logically move to the final step.  At that point, the Fed could realize that it had evolved into an unnecessary appendix.  It could give the nation a wonderful present after presiding over 100 years of bad policy and chaos since its creation and simply disband itself.   In a technologically advanced, instantaneous exchange, debit-card economy, it is high-time to move on from fiat money to a private, market based unit of exchange and valuation.  What could or should that be.  It could be something with engineered, hypothetical scarcity, such as Bitcoins.  We would suggest an exchange and valuation good, a money, based upon the real fundamental value of broad index units of productive capital.

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Part II—Public Debt


7841152_sIt is a sad fact of human nature that many will observe the savings, wealth, or excess of production over consumption of others with greed and envy.

In our island example of private debt, let us now introduce government.  Government might be assumed be elected or imposed.  Suppose the individuals who comprise it look just like anyone else, except let us say that they have armbands with a pronounced “G” printed upon them.

What sets government apart is that these people, through legislation or regulation, have some very special privileges that allow them to violate the normal rules of the marketplace.  The market place, for example, operates under the rule of voluntary exchange and no stealing or taking of property.   The government can take property, income or wealth from others through a number of means that would be illegal for the rest of the population.  Their justification for doing so, of course, is that they employ this power only for “the greater good” of the island society—for example national defense, the general welfare, and various “public” goods which are thought to be inadequately provided by private markets.  The more cynical among us might be excused for believing that governments often exercise these powers instead to feather their own nests or to reward those who allow them to retain power.

How does government succeed in financing itself, in the taking of output or wealth from private individuals?  First, there is direct taxation.  The government can determine tax rates applied to income, returns to capital, trades, property etc.  It can make these tax rates specific to certain types of trades or activities that are either politically favored or disfavored.  Secondly, most governments have the power to exclusively control and issue the fiat currency that is used to accomplish trades in the private sector.  Since this currency is backed by nothing other than the faith of those who use it, this very valuable power can be thought of simply as the exclusive right to be the only legal “counterfeiter.”  A more ponderous power also exercised by government to interfere in the marketplace is the power of mandate.  That is, certain types of disfavored trades can be prohibited whereas other types of favored trades can be required.  Direct mandates tend to be controversial and not very covert.  Therefore, they are the last resort of shrewd politicians.  Finally, of course, governments can borrow.

In borrowing, a government which also has the power to issue fiat money as well as to control and regulate a private banking system holds almost all the cards.  In pernicious and extreme cases it can come to naturally view itself as the sole arbiter of the allocation of private savings.  Thus, it is not only greedy but, if we allow it, it is also in effective control.

How is that?  Let us first consider the advantages of the government as a borrower.  Whatever the required rate of return for private lenders is, the government can meet it.  Why?  Simply because the government has the theoretical power to raise whatever funds are needed for its debt and interest payments through taxes.  This simple fact assures lenders that the government need not default on its loans.  Thus, if lenders believe this, the government benefits from a lower risk-adjusted return required upon its debt and the broad perception of “no credit risk.”  Less attractive to borrowers, of course, the government also has the power to buy its previously issued debt or bonds with newly issued fiat currency.  It can thus “monetize” its previous debt.  By doing this it inflates the currency to the point where the real value of debt (that is, the value of the nominal government bonds in terms of output) is reduced to whatever level the government prefers.   The government can and does alter the supply of fiat currency to artificially manipulate the cost of borrowing in the loan market (that is, to achieve central bank interest rate targets).

Additionally by setting or changing the minimum proportion of vault reserves required within a fractional-reserve banking system, the government has control over the volume of private loans.  Worse, it controls the disposition of these loans through its regulation and licensing of private banks and through the legislative mandates it applies to them.  Put bluntly, an aggressive government can control how much is lent, by whom it is lent, to whom it goes, and at what price.  Clearly, that outcome is not a free market in lending.

It is any surprise that such a control and power over the allocation of aggregate private savings generates credit bubbles or gross distortions?  Our opinion is that such a top-heavy debt and lending system can explain virtually all of them.  Pushed to an extreme, the government’s own debt can become the biggest credit bubble of all.  If government spending growth dramatically exceeds the growth rate of the economy that bears it, an eventual collapse of the entire economy can be the logical result.  This happens.  For example, consider Greece.  Can such government aggressiveness explain the under-investment in capital that occurs in many economies?  Of course!  Not only does capital have to compete for savings on an un-level fiat money playing field, but private capital investment itself can be an officially “disfavored” use of savings.  How?  It is easy—simply raise capital gains rates, or raise corporate income taxes, or increase regulation.  Additionally, government can subsidize preferred types of capital investments and punish those that are out of favor.  Finally, when government abuses its power over private savings to an extreme, the general atmosphere prevailing in the market place discourages all types of private investment or allocation of saving.  Immediate consumption rules!

The bottom line is obvious.  It should come as no surprise that, as a government gets more aggressive in controlling private savings and its allocation, the efficient investment in productive capital may well be the first casualty.  It is no surprise (as we argue in our book Capital as Money) that the likely outcome of such an inefficient lending market is aggregate under-investment in new productive capital.  That is, the result is an economy that simply doesn’t have as much productive capital as it should have to maximize the wealth, economic growth, prosperity, and consumption of its citizens.

Of course, as in the case of private debt, the issue of a unit of public debt does not increase aggregate wealth.  Simplistically the asset value of a piece of government debt to its specific holder is exactly offset by the present value of the taxes required to pay its future stream of interest and principal payments—that is a liability all of us.  In fact, a critical observer may make the following inference:  Given the close historic relationship between public debt and fiat money issuance, issuance of public debt implies a corollary:  the inevitable future issuance of fiat money to monetize it.  This, in turn, implies an increase in the level and volatility of future inflation—tending to impair the wealth, prosperity and growth of the overall economy.  In fact, a good way to view the government’s monopoly of the money supply function is that it is precisely this power that affords governments the only “legal” loophole to effectively default on their debt.  It is exactly analogous to a counterfeiter paying off a loan obligation he has incurred by turning on his printing presses and printing up more bogus currency.  Wealth is destroyed, or at least stolen, by such behavior.

Considering public debt, total debt and its unfortunate de-stabilizing linkage to fiat money and monetary policy, it appears that our money is far too important to leave in the hands of government or central banks.  The supply of money and interest rates should not be gamed but instead should be market determined.  Money is not a public good!  We now have the tools and technology to allow us to choose a private money with a supply determined by private free market demand.  What is it?  Broad productive capital should be used as a unit of value and as a medium of exchange.  The solution is capital as money.

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Part I, Private Debt



This blog is intended to describe how private debt might look in a world that uses productive capital as its money, and is intended to answer questions we have received from several readers of the book.

When thinking about macroeconomics, abstracting to the simplest case is almost always profitable in aiding understanding.  Consider the example of debt in an economy that is devoid of fiat currency.  That is, contemplate debt in a world where we think of consumption and saving in terms of real goods and services, thereby not letting ourselves get confused by various illusions created by fiat money.

Suppose we start with an island consisting of perhaps 200 individuals.  They work singly or as groups (businesses) to produce different types of output and they trade freely with one another to obtain what they need or want.

At any particular time, some of these individuals accumulate more wealth or output than they wish to currently consume.  This excess of production over consumption represents their savings, and they must decide the most profitable way to place it.  In making this decision they must consider risk and potential return.  Of course, their goal is always maximizing their lifetime consumption at an appropriate level of risk.

Let’s start with the case where the only thing they can do with their excess of production over consumption is to invest it.  By “invest” we specifically mean they can create productive tools or knowledge enhancing their own future production, or the future production of other individuals or businesses upon the island.  In making this investment they therefore increase the island’s stock of productive capital available for future output production.  Clearly this is an important function for the future growth and prosperity of the island economy.  As a reward for accumulating capital the savers reap, on average, the marginal product of capital as the reward.  The marginal product of capital is the rate of return that a saver would expect to earn.  By saving, say, 100 bushels of seed corn, the saver might reasonably expect to have 103 bushels of corn the next period—a return of 3 percent.

Starting from that idyllic position, now let us suppose that individuals who enjoy an excess of output over their desired current consumption might do something else with their savings, which is to extend a loan to other individuals (or businesses) on the island.  The potential borrowers are those who would wish to currently consume more than is obtainable with their current production or income.

If borrowing is introduced into our island economy, then those who need more output than they currently produce can offer a price (an interest rate) to entice those with an excess of output to lend it to them.  How can they promise to pay an interest rate with any confidence?  The borrowers must have an expectation or guarantee that their future output or income is going to grow sufficiently over the future to enable the repayment of the interest and principal on their loan or debt.  Or, perhaps the consumption item desired is lumpy, large relative to current income, and infrequently purchased (for example, a house).  In any case, the terms and assurances of the loan is part of the negotiations between borrower and lender.  Moreover, to obtain their loan in a rational world, borrowers must be able to offer an attractive return and risk to the lender.  That is, a borrower must promise to pay the lender a higher risk-adjusted return than the lender might earn himself through his own direct investment in new productive capital.

Will a potential lender be willing to extend someone else a loan if the lender has an ability to use his savings in his own or another’s investment project? That is, if a saver can direct his savings toward accumulating capital (a fishing net, tractor, etc.) for himself, for example, why make a loan to someone else?  He will only offer his savings to a borrower if he can earn a risk-adjusted return which exceeds the expected return to capital.  In an economy that uses capital as the bedrock of value and exchange the return to capital will be viewed as the benchmark return—attainable by the default position of simply accumulating additional units of capital.

A default on a loan occurs when a borrower cannot or will not meet the demands for payment of principal and interest on a loan that was made to him.  Of course, loan defaults will sometimes occur.  Not all loans made will be wise or prudent on the part of the lender or the borrower.  In addition, things will happen—disasters, wars, accidents, and disease are always an unexpected part of human existence.

Where does the introduction of private debt leave us in our overall island economy?  On a macro-level, all loans either allow borrowers to invest or consume.  If all loans were made for purposes of investment, then the economy’s stock of productive capital will be larger than occurs if loans are made for purposes of financing consumption.

We are able to conclude that borrowing amongst individuals is not necessarily helpful in an economy that needs more productive capital.  When an island needs investment, extending loans to individuals for purposes of consumption simply keeps the economy undercapitalized.  Put simply, enabling lending in an economy that starts from a position of putting all of its available savings into investment of new capital cannot possibly result in a larger capital stock.  At most it will be equal and, in fact, probably less.  In any economy, even one that uses capital as money, no one say how much lending will occur in the aggregate or how much is “good.”  If individuals enjoy lending back and forth to one another, the total volume of loans might become huge.  If they primarily invest their excess of production over consumption, the total volume of private debt may be very small.  If loans are predominantly made to businesses which then invest them in new capital creation then the net effect of borrowing upon the creation of new capital may be almost the same as direct investment—although the ownership of the new capital is changed.  The important thing to realize is that, whatever its volume, the stock of private debt does not change our island’s aggregate economic wealth.  Each loan created between a borrower and a lender creates an asset to the lender and imposes an exactly off-setting liability upon the borrower.

Once loan contracts are made, then the ownership of the resultant notes or bonds may be secondarily traded in the marketplace.  One could even visualize private island “raters” who offer valuable and expert opinions as to the likely risk or quality of individual loans or pieces of island debt.  Thus, an islander who now finds themselves with an excess of production of desired current consumption can now invest it, make a new loan with it, or buy an existing loan or bond in the marketplace.

Suppose, for some reason a “lending frenzy” takes place upon our island which produces an enormous stock of aggregate private debt.  Is such an activity to be welcomed or abhorred?  Well, as we have discussed it has no necessary net implications upon the aggregate economy and its net level of consumption or investment.  Thus, we could say in the absence of loan defaults, all loans will be faithfully paid off and size of the total stock of private debt that occurs is irrelevant.

However, in the real world of uncertainty, the more loans that are made the higher is the probability of loan defaults—even if the loans are carefully underwritten.  Of course, the situation is worse if imprudent or poorly underwritten loans flourish.  The reason is that once loans start to default a “death spiral” of debt or bonds can proceed.  As loans default, the price willingly paid for them not surprisingly falls in the market place.  This in turn raises the interest rate required on new loans or the interest payments on loans already made but subject to adjustable interest charges.  In the limiting case a debt crisis or “implosion” can occur with new lending driven to zero.

However, we can place some confidence in the limiting mechanisms of a transparent, simple free loan market.  Although a debt explosion is theoretically possible, it could be argued that, in a rational private lending market, prudent, strong underwriting would be the norm and loan defaults would the exception rather than the rule.  When defaults did happen, they would be isolated and quickly addressed.   Moreover, loan defaults would naturally be immunized or quarantined with consequences largely limited to the individual lenders and borrowers who incurred them.  Secondly, the always present benchmark return to capital would make the occurrence of such a lending “frenzy” difficult to imagine.  To say the least, an always available, unimpaired return to capital would provide a strong, healthy natural brake on the scale of private lending activity.

So far debt seems pretty clear and simple.  What could go wrong with lending in our simple island economy?  The answer lies in governments, public debt, fiat money, taxation or mandates, and a government-regulated private banking system.  We will explore that next.

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Recently our blogs have emphasized the incredible expansion of the stock of high-powered money required to monetize our debt-financed ballooning federal deficits.  Further, we have noted the fact that private banks are effectively being kept on the sidelines by onerous capital requirements, federally mandated lending regulations, or interest payments rewarding them for not lending.  The summary picture that emerges is not a pretty one—but it is a sadly understandable one.


We have an usurping government that is trying to co-opt and control the U.S. lending market.  It is apparently less and less a “market” and more and more a political arm of the government and its current political agendas.  The government’s agenda is explained by the area of economics described as “Public Choice Theory.”  Succinctly, this is the view that political incumbents within a government that possesses the power to “steal” from the private sector through borrowing, taxation, and fiat money creation will tend to reward those constituencies that voted for it at the expense of those who voted against it.

At the present time, things seem to be working well for the stealing.  The velocity of money is logically related to the opportunity cost of holding money.  As long as actual inflation and inflationary expectations are low, the government can issue and the Fed can monetize federal debt with reasonable success.  But what happens when the government inevitably becomes too greedy?  When deficits become too big? And when the required monetization becomes too large? And, yes, we would suggest that a trillion dollars a year of high-powered money expansion is too large to be sustainable.  Also unsustainable and intolerable is our current situation in which too much of our economy’s scarce and precious private savings is being steered into inefficient public programs and expenditure.  The federal government’s expanding student loan program is a prime example.

What will happen, of course, is that the traditional banking industry will probably die (it may be an anachronism anyway as we have argued in our recent book Capital as Money).  What else can happen to banks anyway?  They can only make politically approved loans, they are micro-managed and regulated as an arm of the federal government, and by Fed rate manipulation they are constrained to survive on near zero rates of return.  On the present course the traditional banking industry appears doomed for extinction.

When inflation does inevitably surge, a technologically efficient, rational private economy will display a shrinking willingness to be subjected to the sustained imposition of the inflation tax (read Chapter 5 in Capital as Money—the limits of monetary financing).  The empirical support for this conclusion lies in the frequent lament by central banks worldwide that the “effectiveness” of their monetary policies isn’t what it used to be.  Translated, read this as “it isn’t as easy to steal output from the private sector via printing paper currency as it used to be.”  Velocity has become a market-determined variable rather than a technological constraint.  As prices rise because of government’s attempt to increase its funding from inflationary financing, the velocity of money will increase.  Astute individuals will react to rising prices by increasing their transactions speed in an attempt to reduce their holdings of fiat money balances.  And in today’s economy the limit of the electronic exchange of funds is literally the speed of light.

At the same time direct lending between lenders and borrowers (as opposed to bank or brokered lending) will continue to grow (as it already has) and private investment will be starkly preferred on a risk/return basis to holding fiat money or public debt.  If our government pushes too hard and becomes too greedy in fiat money issuance (and based on history, when have governments not?) then inflation will sharply rise, dissatisfaction with fiat money will mount, and the time will be ripe.  Ripe for what?  Ripe for the transition to a private market real money.  It will be time for a real logical medium of exchange and valuation:  Capital as money.

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“Hey Ed what’s happening?  You look a little down this morning.  Heck I hate to use the term ‘mangy’ but it even looks like you haven’t licked your fur for a week.  It’s sticking out in all directions and, if I may say so, you smell rank.”

“Yeah.  To tell you the truth Jill I’m just not feeling that good.  Two reasons:  First, I just heard that the coyote unemployment rate is sharply up this month and I’m part of it—your brother Jack just fired me.  I’m unemployed.  Second, I haven’t had a nice, fresh rabbit in a long time.  My stomach’s a little upset.  I shouldn’t have eaten that crushed road-kill magpie off the pavement—who knows how long it was there?”

“Ed, what are you talking about?  A coyote can’t be unemployed.  Just go catch a rabbit.  You and I have done it many times down at the dead-end dry gulch.  You chase ‘em in and I’ll rip their little throats out with my dainty sharp teeth!  Just like we always used to do!  What do you say?”

“Oh I don’t know Jill—it’s just not so simple any more.  I’m just not an ‘entrepreneur’ like your brother Jack.  He has everybody specializing at what they’re best at—some at chasing, some at catching, some at skinning and some at guarding the stash.  It’s quite a process now, but apparently I didn’t fit in anywhere, so here I am—fired.”

“Stop feeling sorry for yourself, Ed.  I don’t know what an ‘entrepreneur’ is.  It just sounds like some silly word to me.  Whatever they can do, we can do it too.  Just like we used to—let’s go to the gulch right now and get started.  A little fresh rabbit meat will perk you right up!”

“Jill, you’re still making it too simple.  Catching rabbits now involves bookwork.  President Bark now requires a license for any coyote enterprise that catches rabbits.”

“A license?”

“Yeah.  And that’s not all.  Now there are a lot regulations and paperwork involved.  Kills must be taken fairly and reported.  Part of the rabbits collected must go as taxes to the pack government.  ”


“Yeah, Jill.  Our pack leaders are too busy regulating us to hunt, so they need more rabbits from us. Rabbit taxes also pay for other things such as social security for coyotes in their old age and universal coyote healthcare.  Nowadays one in four rabbits goes to pay taxes.  My head is spinning just talking about it—that’s why I guess I’m not an entrepreneur like Jack.  That’s why I have to wait for someone to employ me.  I even think I’m supposed to get a quota of ‘unemployment’ rabbits, but I don’t see much coming my way.  I’m not holding my breath.”

“Are you kidding me, Ed?  We’re coyotes!  We don’t even have opposable thumbs.  We shouldn’t be worried about licenses and rules.  Forget all that stuff and let’s just go and catch our own rabbits down at the dry gulch.  All your talk has got me mad now.  It will be the worse for the rabbits.  I can taste their blood already when I rip their little throats out.  Just let someone try to stop me!”

“Jules, Bertha, and Tom might just do that Jill.  They could boycott us and picket our kill.  They’re the Concerned Vegan Coyote Committee for the Prevention of Cruelty to Rabbits (CVCCPCR).  They’ve singled out your very throat-tearing style to protest and have lobbied to make it illegal.  If they hear rabbit screams from the dry gulch, you can bet they’ll be there and on us like a shot.”

“Well just what are we supposed to do?  I’m starved!”

“So am I Jill.  The CVCCPCR says that we should learn to be vegan.  They recommend we raid farmer MacDonald’s garden patch and eat his fava beans and arugula.”

“Fava beans and arugula!?”

“It’s supposed to be very healthy.  Farmer MacDonald’s garden is certified organic!”

“I can’t do that Ed.  Where can we go?”

“Well, I understand you can still chase rabbits in Wyoming.”

“Let’s go to Wyoming.”

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taxesOn January 24th we wrote a blog titled The Most Insidious Tax.  In the blog we criticized the wisdom, or lack thereof, in increasing the tax on capital gains from 15% to 20%.  We have decided to expand further on the topic of capital gains taxes, and to speculate on how the economy might change if we could move from fiat money to an economy that uses capital as money.

What is the historical long-term average rate of return to broad productive capital?  In terms of the S&P 500 Index, an index composed of the 500 largest U.S. companies, the average annualized total rate of return has been in the range of 9-10%.  This total return is composed of dividends and price appreciation.  Presently the average tax rate applied (capital gains and income tax on dividends) takes away 20% of this amount.  Thus, going forward we might reasonably expect an after-tax return of about 8%.

In addition to taxes, inflation also impacts returns.  Historically, the average U.S. inflation rate has been 3%, which has reduced the annual rate of return to capital when measured in real terms.  Using history as our guide, as a consequence of taxes and inflation the real, after-tax return to owners of capital in the U.S. is expected to be in the range of 4% to 5% per year.

If we move to a capital-as-money economy, the return to ownership of capital should initially surge. We will not have to pay inflation-induced capital gains taxes in an economy that uses capital as money.  As was stated in a previous blog, in a fiat-money economy a negative consequence of excessive money printing is inflation, resulting in price appreciation in real assets.  To the IRS price appreciation is a capital gain, even if the price appreciation is only a consequence of a higher overall price level.

By way of contrast, consider what happens when broad capital (the tools of production) is used as money.   When an index share is the “numeraire,” the index share would maintain a value of “one.”  In a fiat-money economy, capital gains taxes are collected on assets that change in value relative to the monetary good.  Printing more fiat money makes the prices of real capital assets rise, resulting in more tax revenue for Uncle Sam. This is a hideous disadvantage to capital ownership in an inflating fiat-money economy.   The elimination of this tax is a terrific advantage resulting from movement to a capital-as-money economy.  When capital is money, the return to capital will be reflected in the steadily decreasing prices of the other goods and services for which a unit of broad capital can be traded.   But, if capital is used as money, capital itself cannot experience a capital gain (just as presently it is impossible to have a capital gain on the ownership of a one dollar bill).

In a capital-as-money economy, reduced capital gains taxes and the absence of fiat-money inflation will make the ownership of capital more attractive.  Furthermore, our present system of fiat-money and fractional-reserve banking wastes valuable savings by directing loans to frivolous consumption, rather than towards worthwhile investment in the tools of production.  We need to move away from an inefficient system designed to meet voguish political agendas.  Doing so would cause investment in productive capital to naturally rise.

So, using capital as money would reduce taxes on capital and also eliminate the negative impact of inflation.  But there is still another advantage of using capital as money.  Stock ownership becomes less risky when capital is the numeraire. Presently the dramatic swings we see in the price of stocks is largely a consequence of the veil of fiat money fluctuations.  Stocks appear volatile because their prices are measured in fiat money.  Elimination of fiat money makes capital appear more stable, and capital’s ownership is more attractive.

For all these reasons, we believe the initial impact of movement to a capital-as-money economy would be a surge of investment in productive capital.  Ultimately the increasing capital-to-labor ratio would improve our standard of living.  However, the law of diminishing returns remains fully operational.  In competitive markets the marginal product of capital is also equal to capital’s rate of return.  As capital increases, diminishing returns works to reduce its marginal product, and its rate of return.  Ultimately, the neoclassical growth model suggests the increased investment in productive capital should persist until capital’s average real rate of return declines to 3% to 4%–equal to the average growth rate of the economy (see Capital as Money, and also our September blog titled On Equity Returns and Growth).

“So what?” you may be thinking.   “Why do I care if the capital-to-labor ratio increases?” The answer to this question is important.  An economy that is operating with less capital than it should have is an economy that is forgoing valuable output and prosperity for its people.   It is operating below the capital-per-worker level it should be at in order to maximize sustained consumption, called the “Golden-Rule” by economists (again, see Capital as Money).

Just as the opportunity cost of an “under-capitalized” economy is staggering, the prosperity bonus to the average American of moving to an optimally-capitalized economy would be equally huge.  Adequate investment in capital is so beneficial to all of us, that anything that interferes with it (inflation, capital taxes, and/or inefficient allocation of our society’s scarce savings) is to be abhorred.  Put simply, productive capital is the tools that are used to produce available output for the quality of life and welfare of our citizens.  If, as we believe, our economy doesn’t have as many productive tools as it should, then the gain resulting from employing capital as money looms large.  Capital as money could create increased wealth, consumption, jobs, wages and prosperity for all of us.  Capital is the very foundation of wealth, which is precisely why it should be used as our money.

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Recently the U.S. government raised the long-term capital gains tax rate from 15% to 20%.  Think for a second what this means.  Think what a “capital gains tax” really is in a fiat money economy.   It may be the perfect tax for targeting and destroying what remains of private ownership and freedom.  Why?

When a government or central bank prints worthless fiat currency, such as our Fed does, it steals real output from the private sector by issuing a currency that is steadily shrinking in value in exchange for real goods and services.  This is what is referred to as an “inflation” tax.  It can be collected by counterfeiters and especially the largest counterfeiters of all—central banks.

Now simple logic tells us that the more a government abuses its monopoly of printing new money, the higher the inflation tax will be.  Therefore, the higher will be the appreciation of all real goods and assets measured in terms of fiat currency.  So when these goods and assets are traded, the higher, therefore, will be the realized “capital gain.”  Talk about gaming a rigged system.  The government will get you coming and going.  First, with the inflation tax and then with the arbitrary capital gains tax collected in terms of an increasing value of real goods and assets measured in terms of its weakening currency.  It’s a perfect example of the government having its cake and eating it too.  Practiced to an extreme, it’s perhaps the ultimate scheme for destroying private property.

Now consider how such a “tax” would work in a world using capital as money.

Of course, “capital gains” taxes would not be collected on appreciation of broad productive capital because, as money, capital would be the numeraire good in which all other goods and services were valued.  That is, by definition the value of a unit of broad productive capital in terms of itself would always simply be just 1—as the value of a single unit of any money is always just a unit of itself.  Therefore, on average, there would be no “capital gains” tax on productive capital.

If such an insidious tax persisted, it would largely be de-fanged because it would only be collected on extraordinary gains of other single goods and assets relative to the average value of the money or valuation good.  Since the value of broad capital would be growing at rate over time equal to the sustained rate of growth of the economy (for a more detailed explanation see  our book Capital as Money), you would not expect to see a large set of goods or assets whose rate of return would steadily exceed that.

This is why the ownership of broad productive capital seems to us the compelling choice for money.  Imagine an asset used for exchange and valuation whose own value steadily grows over time in terms of consumption goods and services.  What a recipe for peaceful sleep by money holders!  What an antidote for a weary world historically on the wrong end of the traditional government/central bank inflation game.  In fact, “inflation” would be an alien and odd concept in such a world.  It is the primary logic for choosing capital as money.

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cartoon person relaxing in chairIn  August of 2012 the U.S. labor force participation rate sank to 63.5 percent, the lowest mark recorded in the past 30 years.  The declining labor force participation rate is occurring at the same time the unemployment rate is dropping; the rate of unemployment has fallen from 10 percent in October 2009 to 7.8 percent in December 2012.

 How are the falling unemployment and labor force participation rates related? To answer this question it is useful to examine what it means to be in the labor force, and also what it means to be unemployed.  According to the definitions of the Bureau of Labor Statistics, to be in the labor force somebody must either be employed or unemployed. This seems straightforward, but we also need to understand that being “unemployed” does not simply mean not having a job.  To be considered “unemployed” a person must not only be out of work, but also must be willing and able to work.  A person is not counted as being in the labor force or as being unemployed if he decides he no longer has any desire to find a job.   As a result, when a person without a job decides he is no longer interested in looking for work, then both the labor force participation rate and the unemployment rate will simultaneously fall.

 An examination of the data reveals that labor force participation rates have declined most dramatically for young adults.  According to the Bureau of Labor Statistics (, labor force participation rates for the cohort ages 16 to 24 have declined from 65.4 percent in 2000 to 55.2 percent in 2010. 

 One explanation for the recent drop in labor force participation is that job-seekers have become discouraged, and therefore simply quit looking for work.  But, we think there may be another, greater force at work here.  In the case of young adults, the decline in labor force participation is very sharp.  Many observers believe this may be a consequence of an increase in the number of students attending college—a full-time student is not part of the labor force if he/she is not interested in working while going to school.

 Not coincidently, at the same time young people are exiting the labor force the amount of student loan debt has skyrocketed.  Student loan debt is increasingly owed to the federal government, as private lenders are unable to compete with the attractive loan repayment plans offered by Uncle Sam.  In fact, the U.S. Department of Education encourages students to eschew private lenders, and promotes their own their own taxpayer-financed loans instead.    Quoting from the Department of Education’s website (, “when it comes to paying for college, career school, or graduate school, federal student loans offer several advantages over private student loans.”  The Department of Education lists many of the benefits of federal student loans when compared to private loans.  For example, the Dept. notes that private loans may require a credit check, whereas “you don’t need to get a credit check for most federal student loans.” Another so-called advantage of federal loans is that  “you may be eligible to have some portion of your loans forgiven if you work in public service.  Learn about our loan forgiveness programs.” (Read, don’t worry too much about whether or not you can pay back the loan—taxpayers have you covered).

 Is it any wonder the growth rate in GDP is miserable? The U.S. government and its money-creating ally (the Federal Reserve) are great at finding ways to encourage people to avoid productive employment.  Going to school through student loans, which may never have to be repaid, is a big deterrent to entering the labor force.  But, there are many other ways to get some cash without breaking a sweat.  For instance, part of the deal that was cut to resolve the “Fiscal Cliff” involved maintaining the availability of “extended” unemployment benefits.  Simple economic logic suggests increasing the duration of unemployment benefits does little to encourage people to accept less-than-desirable work.  Instead, like Eddie in the movie Christmas Vacation, it is better to hold out for a “management position.”

Will our economy ever again experience robust growth?  It may, but only if the federal government stops distorting incentives and discouraging productive people from working.  Printing money and throwing it around willy-nilly isn’t the way to promote a healthy economy.  Private markets should determine who gets student loans and who doesn’t.   And, the hurdle rate on student loans should be high—at least as high as what could be earned by owning a diversified portfolio of capital assets.  In such a world, a potential borrower would have to carefully weigh the costs and benefits of the borrowing decision.  Ultimately, things get properly balanced only when we get government out of the lending business, and also out of the money-printing business. Read Capital as Money!

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Capital as Money

Capital as Money is now available as a paperback, or as an e-book.  Either one can be purchased by visiting

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