The Book

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.


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.


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.


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.


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!


Capital as Money

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


In our December 20th blog we suggested that any last minute deal to resolve the Fiscal Cliff was unlikely to produce a meaningful change in the size or scope of the federal government.  To quote our earlier blog:

“So, let’s get back to the fiscal cliff. Why do we hope a deal isn’t reached? Simply because of the automatic spending cuts that are scheduled to occur if there is no deal! We’d like to see government spending decline as a percentage of GDP. In fact for the long-term health of the U.S. economy we think a federal spending decline is imperative. Any other sort of deal that is struck between the President and Congress is likely to involve a few symbolic gestures such as a higher tax rate on ‘rich’ people, while diverting attention away from the one real concern, which is the size of the overall bite the federal government is stealing from the GDP pie.”

Sad Face

Contrary to our hope, in the past two days a deal was struck.  And, unfortunately, our prediction of what the deal might look like was spot on.  (We should not boast about our forecasting prowess, as anyone who has been watching Congress could see it coming.)  The details of the deal involve a few tax hikes targeted at the wealthy.  Namely, the tax rate on those individuals making over $400,000 is increased from 35 percent to 39.6 percent, and the capital gains tax rate is increased from 15 percent to 20 percent. Also the payroll tax rate will go up by 2 percent (on everyone, not just on “rich” people).

OK, so that is the outcome on the tax side of the picture.  But what about those automatic spending cuts which were scheduled to occur?  Well, the decision was to postpone those.  Rather than letting the automatic cuts happen, Congress will wait 60 days and then get to work on the spending side of the equation (yeah, right).

Bottom line:  The federal government is going to continue to run enormous budget deficits, financed by monetization of the debt by the Federal Reserve.  As long as the government can postpone any spending cuts through the printing of new fiat money, any real progress on lowering the national debt is unlikely.  Printing new fiat currency is the way out (at this point perhaps the only way out) for an enormous, past-the “tipping-point,” rapidly growing government sector. Only by switching to a “money” whose value depends on something real (i.e. physical capital) could this process be reversed (read Capital as Money).  Meanwhile we can make another no-brainer forecast, given that converting debt to currency is the last refuge for the financing of out-of control government expenditure, the prudent might batten down the hatches in expectation of rising inflation during the next few years.


The Tipping Point:

The reader of the first part of our “Fiscal Cliff” may have noticed our concern with total federal government expenditure exceeding the level of 19-20% of the U.S. economy (G/Y > 20%). Why is this number so important? It’s a simple exercise in economic logic. As we move along the spectrum from a government taking 0% to 100% of its citizen’s production, there will be some point at which a market economy begins to sour and its economic robustness and enthusiasm begins to decline. Experience indicates that this point in our economy has occurred at levels of sustained economic expenditure by the federal government in excess of 20% of GDP. It is here that private investment, new enterprise formation, economic growth, and private employment growth begin to disappoint. So-called “animal” spirits and the enthusiasm of free markets and capitalism begin to slacken. That is why our current level of federal expenditure of 25% of output is alarming (more like 40% if state and local governments are included).

The dynamic will be negative when we cross the tipping point. It is easy to imagine the road to a socialist state starting from a point of a government able to supply resources to its entitlements and dependents only by taking larger and larger shares of a shrinking and apparently underperforming private sector. The government would justify this behavior by “rescuing” more businesses and owning a bigger proportion of our economy and our lives. The eventual outcome for our country could be some sort of recreation on a larger scale of the drab and dismal examples of the decline of Europe under the paternal state socialisms of the sixties and seventies –recall Harold Wilson’s Britain, for example.

The Citizen’s Perspective :

When we see such a risk, many of us may wonder how individual Americans can tolerate or support such an outcome. What are individuals thinking who vote for or support such actions by the Federal Government? We see several possibilities:

(1) They might believe the expanding federal government budget is only a temporary, emergency level of spending that will be reversed as soon as the economy recovers. To see that this view is wrong we only need to observe that the current depression/recession endured by the U.S. economy is approaching record duration—even when compared to the Great Depression of the 1930s. Good luck! We hope you are right. Going over the fiscal cliff will prove it, if government expenditure is actually tamed. But remember, many a taking of citizen’s individual and economic freedoms and property has been justified by being referred to as a “temporary” measure.

(2) They may be unaware of these issues or their importance. Indefensible, but, alas, a more common position than we may care to admit. Ignorance, of course, endangers freedom.

(3) As bureaucrats or other receivers of the federal largesse, supporters of the growing government may rationally believe that, in their personal case, what is being expropriated away from them is less than what is being transferred back. What is missing from their calculation of course is the declining trajectory of output and economic growth over the future that will replenish the trough from which they dip.

(4) They have a large heart or a sensitive conscience. They believe it is important to take care of those in our society who are less fortunate, or more dependent. It is hard to impugn these admirable motives, perhaps shared by many or practically all of us. Yet we might ask ourselves if government programs and spending are the best way to achieve this goal. We would do well to read, for example, Milton Friedman’s Capitalism and Freedom. There we would be reminded of the dismally tiny fraction of each dollar of funding that actually trickles down through federal programs to support needy or dependent citizens after going through the hands of politicians, feather-bedding bureaucrats, entrenched lobbyists, and empire-builders. Friedman contrasts this to the robust private charity of churches and communities that existed during the nineteenth century in the U.S.—when there were no federal government safety nets. He suggests that period of private charity was superior and more moral in meeting dire human needs. If a person’s barn or house burned down, his neighbors or friends rebuilt it. That admirable motive for generous behavior still exists. However, now many believe that some government program would doubtless take care of a problem with our expensive tax dollars, and therefore would turn a deaf ear to pleas for help. The irony is that it is likely that the reassuringly-named government program would likely fail to actually provide the needed aid. We might ask ourselves which is more moral, a self-perpetuating state socialism that manages and controls the lives of its citizens while engorging itself, or free individuals wrestling with their own consciences in deciding what they should give to support the needy and unfortunate amongst them.

The immediate objection may be raised that privately provided aid is not universal and may be applied with a bias. If that is so, then, in the free-market of charity, new ones may be created which are not selective or do not serve such biases. In today’s America, who amongst us still believes that the individual programs within the staggering array of federal expenditure are not biased, selective, or politically motivated?

Taming Government Expenditure:

Going over the “fiscal cliff” is important if it actually results in the brakes being applied to government expenditure. Then it will re-affirm that the majority of our elected representatives actually still value and appreciate the strength of a private free-market economy. If tax rates are simply raised with no cuts in spending, the result will be dismal. Tax revenues actually collected at the higher tax rates will likely be lower rather than higher, deficits will continue to swell, economic performance will stagnate, and we will likely be past the tipping point.

An equally or even more important way to tame G/Y is, of course, the subject of our recent book, Capital as Money. Reform of our obsolete and de-stabilizing structure of fiat money and fractional-reserve banking is critical to the future performance and stability of our economy. We have the capability and technological tools at hand to create such a private money. A “capital-as-money” economy would remove a covert financing tool from the federal government that is perhaps more important and even more abused than taxes. If you haven’t already done so, you should read it. As we stated previously, most of us don’t like direct taxes and if the financing of government expenditure cannot be made covert, by inflationary printing of fiat money or borrowing for example, then the government expenditure, thus financed, is less likely to happen.

Ironically, not a great deal is required of the government, its political courage, or its behavior. Even a slowly but positively growing economy can forgive many sins. The federal government can get away with not cutting the absolute level of expenditure or even eliminating programs. It simply must follow the rule of limiting the growth of such programs to be less than the growth rate of the overall economy for a period of time. If that is done, if the greed of government can be reduced to just that level, then the government sector will gradually shrink relative to the private sector and G/Y can decline to a healthy level. Of course, this process will be sped up if government spending is actually cut or programs eliminated. Eventually we could get to a government sector spending only 7% (or some other number less than 20%) of GDP through government only growing itself more slowly than the average of the economy. However, this outcome would not be viewed with much enthusiasm by those politicians who are primarily interested in controlling larger and larger portions of their citizens’ economic and political lives.

Many of us, including some of our elected leaders see nothing exceptional or grand in our forefathers’ vision of individual liberty, economic freedom, and individual autonomy and responsibility. They may even view these ideals as unworkable, obsolete, or quaint, in the modern world. Unfortunately, until this perception is reversed in a majority of our citizens, darker days may lie ahead for America.


The so-called “fiscal cliff” has created quite a stir. At issue is a set of automatic spending cuts and tax increases scheduled to go into effect on January 1, 2013. The news networks (particularly CNBC) have been hammering on this voguish topic for weeks, urging Congress and the President to DO SOMETHING! The impression is given that disaster is inevitable if an agreement isn’t reached, and fast.

For our own part, we hope we go over the cliff. It’s not that we’re big proponents of tax increases. But we do understand what the effective tax rate really is. When trying to decide whether taxes are high or low, it is not necessary to examine marginal tax rates applied to personal income or corporate income, or to do a careful analysis of gasoline taxes, or tariffs, or any other of the myriad of federal government taxes. We need not debate supply-side effects or the absence of them or whether one type of tax is to be preferred to another. One need only look at the ratio of government spending (G) to GDP (Y). When the ratio of G/Y is high, then the tax rate is high—if G/Y is low, then the tax rate is low (of course, “low” doesn’t happen much anymore).

Professor Steve Hanke of The John Hopkins University recently published an informative article examining the growth of federal government spending (see “An Age of Illusionists,” in GlobeAsia, December 2012). Professor Hanke calculated federal government spending as a percentage of GDP going back to 1952. Not surprisingly, today’s ratio of approximately 25 percent is higher than existed in any previous presidential administration during the period Professor Hanke considered. The low of 16.5 percent was recorded during the Eisenhower Administration. Interestingly, when the total federal take from the private sector exceeds the threshold of 19-20 percent, it has corresponded to periods of particularly tough sledding for the U.S. economy—that is inflation, stagflation, slow real growth and high unemployment. This has been noted as kind of a “spending limit” by a number of economic observers, including several members of previous administrations’ Council of Economic Advisors.

In case it is not obvious, perhaps we should clarify why the 25 percent figure is the real tax rate faced by the average person. GDP is the total amount of goods and services produced in an economy during a year. Clearly, the federal government can purchase 25 percent of the stuff that is produced only if private purchases are reduced by 25 percent. It is really that simple; if one party gets to eat 25 percent of the pie, then 75 percent is left for others to consume. Government finances its spending in one of three ways, which are direct taxation, new money creation, and borrowing. The various approaches to finance government spending differ in how goods and services are transferred from the private sector to the government, but in all cases the end result is that less private spending is required in order for there to be more government purchases.

Imagine a government that finances its spending entirely through the direct taxation of the income of its citizens. This would be an honest way for a government to finance itself and, of course, a government could purchase 25 percent of an economy’s GDP only if the tax rate was, on average, 25 percent. If the government wanted to increase its purchases to 30 percent of GDP, then a 30 percent tax rate would need to be applied.

Most people don’t like taxes (especially when they fall specifically on them), so the government often turns to a second approach for financing itself: it buys goods and services through expanding the money supply. Money financing occurs whenever the Federal Reserve creates new money in order to buy government bonds. From the government’s perspective, this approach to financing its purchases is appealing because it might fool some people into thinking the tax rate is less than it really is. But there is no magic associated with the printing of new money. As is the case with income taxes, government can consume 25 percent of the economy’s GDP only if it is taken from the private sector. In the case of printing money, the GDP is stolen from the private sector through the mechanism of higher prices. As prices rise, the typical person can purchase less—25 percent less to be precise. The inflation tax might fall on different people than a more honest income tax, but in the aggregate the end result is the same.

Finally, the third way government can finance itself is by borrowing from its citizens. Of course, the problem with this approach is that those citizens who are being borrowed from will necessarily have to pay themselves back through higher taxes in the future. Again when all the dust settles the outcome is the same—government consumes 25 percent of the economy’s total production only if the private sector consumes 25 percent less. The simple way to visualize bond financing is “ tax me later rather than tax me now.”

So, let’s get back to the fiscal cliff. Why do we hope a deal isn’t reached? Simply because of the automatic spending cuts that are scheduled to occur if there is no deal! We’d like to see government spending decline as a percentage of GDP. In fact for the long-term health of the U.S. economy we think a federal spending decline is imperative. Any other sort of deal that is struck between the President and Congress is likely to involve a few symbolic gestures such as a higher tax rate on “rich” people, while diverting attention away from the one real concern, which is the size of the overall bite the federal government is stealing from the GDP pie.

What would the original writers of the U.S. constitution think of a federal elected government that was stealing 25 percent of total output? They would no doubt be shocked and awestruck that the game “of rewarding those who voted for you by taxing those who voted against you” had come to this sorry point. They would probably hurry back to their draft and put in the missing part of our constitution. The missing part, which is desperately needed, would define the scope of government spending and functions and provide a reasonable limit on what can be stolen or spent. Twenty-five percent? We like a number such as 7 percent better. Surely a trillion dollars (2012) is enough to provide for the national defense and to protect citizens rights, freedoms and property.



Are you among those who have considered the morass of the United States’ and world monetary system with concern and dismay?

Have you wondered if there is a workable alternative?

The purpose of our book, “Capital as Money,” is to demonstrate, by means of a simple and enjoyable story, that we have the technology and tools to evolve to a truly endogenous private system of exchange and valuation—of money.  Under such a voluntary arrangement, the volume of “money” and the speed at which it is exchanged is simply determined by private need and desire, not by some policy imposed by a central bank or the accidental and destabilizing results of lending within a fractional-reserve banking system.

Imagine a world in which the unit of exchange (productive capital) gradually increases in average purchasing power—a world in which sustained inflation is a foreign concept.

We believe that markets now have the tools and the ability to evolve to such a world, a world of productive capital as money.  What is needed from us is the will and imagination to make the change.

Is the value of aggregate productive capital in an economy naturally volatile?  Perhaps. There may be some volatility associated with what a unit of capital (for example, a tractor) can produce.   More likely the uncertainty in the value of future income streams to capital is caused by fluctuations in central bank monetary policy, causing variability in the stock of fiat money, and inevitably inflation.  Capital appears volatile only because it is viewed through the lens of fiat money.

To those who would argue that a central bank is needed to wisely intervene through monetary policy to stabilize and micro-manage a private economy, we would offer the following historical food for thought.

Since 1999, the United States Federal Reserve, under two chairmen, dramatically expanded the money supply and lowered the target short-term interest rates to nearly zero following the 2001 terrorist attacks.  Then, after spawning a crazed explosion of loans and mortgages up through 2005, the Fed stepped on the brakes, slowing money growth and raising the target Federal Funds Rate to over 6 percent.  This extreme “roller-coaster” policy caused the predictable collapse of a vulnerable credit market, housing market, and a decline in the U.S.economy that has rivaled the Great Depression in duration.  The Fed then responded by lowering target short-term rates to nearly zero and the record but fruitless expansions of the money supply represented by quantitative easings I, II, and III.

A skeptical observer of all this is justified in asking, “Might the economy have been more stable and the two recessions either avoided or less catastrophic over the period 1999-2012 if the Fed had simply held the Federal Funds Rate target stable at say some reasonable intermediate level such as 3 percent?  Stabilization policy indeed!

If the last decade and a half are representative of stabilization policy by the Fed, please spare us from any more.


You need to read “Capital as Money.”


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