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TWO CENTS'
WORTH
Opinion by Henry C K
Liu
The global
economy in transition
Henry C K Liu was invited
to give a lecture at the Seventh International
Conference on Economics held on September 6-9 at the
Economic Research Center of the Middle East Technical
University in Ankara. The conference brought together
from all over the world prominent economists with
diverse viewpoints and special expertise, ranging from
central bankers and policy specialists to academicians
and scholars. The ideological range covered
neo-classical to Marxist economics, as well as
apolitical macroeconomics and mathematical modeling
experts.
Liu's lecture discussed the global
economy in transition, focusing on the changing nature
and role of money, debt, trade, markets and development.
In summary, the lecture presented the view that an
economy is not an abstraction. An economy is the
material manifestation of a political system, which in
turn is the interplay of group interests representing,
among others, gender, age, religion, property, class,
sector, region or nation. This is an edited version.
Individual interests are not issues of politics.
Therefore, the politics of individualism is an oxymoron
and, by extension, the Hayekian notion of a market of
individual decisions is an ideological fantasy. Markets
are phenomena of large numbers and herd instinct where
unique individualism is of little consequence. The
defining basis of politics is power, which takes many
forms: moral, intellectual, financial, electoral and
military. In an overcapacity environment, company
executives lament about the loss of pricing power. The
global economy is the material manifestation of the
global geopolitical system, and global macroeconomics is
the rationalization of that geopolitical system.
The nomenclature of economics reflects, and in
turn dictates, the logic of the economic system. Terms
such as money, capital, labor, debt, interest, profits,
employment, market, etc, have been conceptualized to
describe components of an artificial material system
created by power politics. The concept of the economic
man who presumably always acts in his self-interest is a
gross abstraction based on the flawed assumption of
market participants acting with perfect information and
clear understanding of its meanings. The pervasive use
of these terms over time disguises the artificial system
as the product of natural laws, rather than the
conceptual components of power politics. Just as
monarchism was rationalized as a natural law of politics
in the past, the same is true with market capitalism
today.
The market is not the economy. It is only
one aspect of the economy. A market economy can be
viewed as an aberration of human civilization. People
trade to compensate for deficiencies in their current
state of development. Exploitation is slavery, not
trade. Imperialism is exploitation on an international
level. Neo-imperialism after the end of the Cold War
takes the form of neo-liberal international trade.
Free trade cannot exist without protection from
systemic coercion. To participate in free trade, a
trader must have something with which to trade
voluntarily in a market free of systemic coercion. That
tradable something comes from development, which is a
process of self-betterment. International trade is not
development, although it can contribute to domestic
development. Domestic development must take precedence
over international trade, which is a system of external
transactions supposedly to augment domestic development.
But neo-liberal international trade since the end of the
Cold War has increasingly preempted domestic development
in both the center and the periphery. Global trade has
become a vehicle for exploitation of the weak to
strengthen the strong. Aside from being unjust,
neo-liberal global trade as it currently exists is
unsustainable, because the transfer of wealth from the
poor to the rich is unsustainable. Neo-liberal claims of
fair benefits of liberalized trade to the poor of the
world, both in the center and the peripheral, are simply
not supported by facts.
Most monetary economists
view government-issued money as a sovereign debt
instrument with zero maturity, historically derived from
the bill of exchange in free banking. This view is valid
for specie money, which is a certificate that can claim
on demand a prescribed amount of gold or other specie of
value. Government-issued fiat money, on the other hand,
is not a sovereign debt but a sovereign credit
instrument. Sovereign government bonds are sovereign
debt while local government bonds are institutional
debt, but not sovereign debt because local governments
cannot print money. When money buys bonds, the
transaction represents credit canceling debt. The
relationship is rather straightforward, but of
fundamental importance.
If fiat money is not
sovereign debt, then the entire conceptual structure of
capitalism is subject to reordering, just as physics was
subject to reordering when man's world view changed with
the realization that the earth is not stationary nor is
it the center of the universe. For one thing, capital
formation for socially useful development will be
exposed as a cruel hoax. With sovereign credit, there is
no need for capital formation for socially useful
development. For another, private savings are not
necessary to finance development, since private savings
are not required for the supply of sovereign credit.
With sovereign credit, labor should be in perpetual
shortage, and the price of labor should constantly rise.
A vibrant economy is one in which there is labor
shortage. Private savings are needed only for private
investment that has no social purpose or value. Savings
are deflationary without full employment, as savings
reduces current consumption to provide investment to
increase future supply. Say's Law of supply creating its
own demand is a very special situation that is operative
only under full employment. Say's Law ignores a critical
time lag between supply and demand that can be fatal to
a fast-moving modern economy. Savings require interest
payments, the compounding of which will regressively
make any financial system unsustainable. The religions
forbade usury for very practical reasons.
Fiat
money issued by government is now legal tender in all
modern national economies since the collapse of the
Bretton Woods regime of fixed exchange rates linked to a
gold-backed dollar in 1971. The State Theory of Money
(Chartalism) holds that the general acceptance of
government-issued fiat currency rests fundamentally on
government's authority to tax. Government's willingness
to accept the currency it issues for payment of taxes
gives the issuance currency within a national economy.
That currency is sovereign credit for tax liabilities,
which are dischargeable by credit instruments issued by
government. When issuing fiat money, the government owes
no one anything except to make good a promise to accept
its money for tax payment. A central banking regime
operates on the notion of government-issued fiat money
as sovereign credit. That is the essential difference
between central banking with government-issued fiat
money, which is a sovereign credit instrument, and free
banking with privately issued specie money, which is a
bank IOU that allows the holder to claim the gold behind
it.
US president Thomas Jefferson prophesied:
"If the American people allow the banks to control the
issuance of their currency, first by inflation, and then
by deflation, the banks and corporations that will grow
up around them will deprive people of all property until
their children will wake up homeless on the continent
their fathers occupied ... The issuing power of money
should be taken from the banks and restored to Congress
and the people to whom it belongs." It was a definitive
statement against the "political independence" of
central banks. This warning applies to the people of the
world as well.
The Independent Treasury Act,
passed in 1840, removed the federal government from
involvement with the United States' banking system by
establishing federal depositories for public funds
instead of keeping the money in national, state, or
private banks. Under the Independent Treasury Act, bank
notes were to be gradually phased out for payments to
and from the government; by June 30, 1843, only hard
money was to be accepted.
The Whigs, led by
Henry Clay and Daniel Webster, opposed the Independent
Treasury, but not to favor private banking. They were
committed to the re-establishment of a national bank
like the one president Andrew Jackson abolished in 1832.
After winning a congressional majority in the election
of 1840, the Whigs succeeded in repealing the
Independent Treasury Act on August 13, 1841, although
they were unable to gain the support of President John
Tyler for their national bank proposal. The return of
the Democrats to power after the election of 1844 led to
the passage in 1846 of a new Independent Treasury Act,
nearly identical to that of 1840. This legislation
remained substantially unchanged until passage of the
Federal Reserve Act in 1913, which established central
banking in the US.
When the Civil War began in
1861, the newly installed president, Abraham Lincoln,
finding the Independent Treasury empty and payments in
gold having to be suspended, appealed in vain to the
state-chartered private banks for loans to pay for
supplies needed to mobilize and equip the Union Army. At
that time, there were 1,600 banks chartered by 29
different states, and altogether they were issuing 7,000
different kinds of banknotes in circulation. Lincoln
immediately induced the Congress to pass the Legal
Tender Act of 1862 to authorize the issuing of
government notes (called greenbacks) without any reserve
or specie basis, on a par with bank notes backed by
specie, promising to pay "on demand" the amount shown on
the face of the note with another note of same value.
The greenbacks were supposed to be gradually withdrawn
through payment of taxes, as specified in the Funding
Act of 1866, to allow the government to redeem these
greenback notes in an orderly way without interest.
Still, during the gloomiest period of the war
when Union victory was in serious doubt, the greenback
had a market price of only 39 cents in gold. The fall in
value was related to the survival prospect of the Union,
not to loss of specie basis, which was non-existent.
After the war, the Supreme Court in a series of cases
declared the Legal Tender Act constitutional and
Congress decreed that greenbacks then outstanding would
remain a permanent part of the nation's currency.
Indisputably, these greenback notes helped Lincoln save
the Union. Lincoln wrote: "We finally accomplished it
and gave to the people of this Republic the greatest
blessing they ever had - their own paper to pay their
own debts." The importance of this lesson was never
taught to the world's governments by neo-liberal
monetarists.
Government levies taxes not to
finance its operations, but to give value to its fiat
money as credit instruments. If it chooses to,
government can finance its operation entirely through
user fees, as some fiscal conservatives suggest.
Government needs never be indebted to the public. It
creates a government debt component to anchor the debt
market, not because it needs money. Technically,
government never borrows. It issues tax credit in the
form of fiat money. So when US president Ronald Reagan
said the government does not make any money, only the
private sector does, he was merely mouthing a political
slogan, with no clear understanding of the true nature
of money and credit. Fiat money is all that government
makes, freely and without constraint, as Federal Reserve
governor Ben S Bernanke recently warned in a speech on
deflation. And only government can make fiat money as
sovereign credit.
Sovereign debt is a pretend
game to make private debts tradable. The relationship
between assets and liabilities is expressed as credit or
debt, with the designation determined by the flow of
obligation. A flow from asset to liability is known as
credit, the reverse is known as debt. A creditor is one
who reduces his liability to increase his assets, which
include the right of collection on the liabilities of
his debtors.
The state, representing the people,
owns all assets of a nation not assigned to the private
sector. Thus the state's assets is the national wealth
less that portion of private sector wealth after tax
liabilities, and all other claims on the private sector
by sovereign rights. Privatization generally reduces
state assets. As long as a state exists, its credit is
limited only by the national wealth. If sovereign credit
is used to increase national wealth, then sovereign
credit is limitless as long as the growth of national
wealth keeps pace with the growth of sovereign credit.
Even if the private sector has been assigned all of a
nation's tangible assets, the state, by virtual of its
existence, can still claim that portion of private
sector assets allowed by the constitutional regime. Such
claims include the state's power of taxation,
nationalization, confiscation, condemnation by eminent
domain and the power to grant and revoke monopolies, and
above all, the power to issue legal tender by fiat - in
other words, the inherent rights of sovereignty.
When the state issues money as legal tender, it
issues a monetary instrument backed by its sovereign
rights, which includes taxation. The state never owes
debts except specifically so denoted voluntarily. When a
state borrows in order to avoid levying or raising
taxes, it is a political expedience, not a financial
necessity. When a state borrows, through the selling of
government bonds denominated in its own currency, it is
withdrawing previously issued sovereign credit from the
financial system. When a state borrows foreign currency,
it forfeits its sovereign credit privilege and reduces
itself to an ordinary debtor because the state cannot
issue foreign currency.
Government bonds can act
as absorber of credit from the private sector.
Government bonds in the United States, through dollar
hegemony, enjoy the highest credit rating, topping a
credit risk pyramid in the international debt market.
Dollar hegemony is a geopolitical phenomenon in which
the US dollar, a fiat currency, assumes the status of
primary reserve currency of the international finance
architecture. Yet architecture is an art of esthetics in
the moral-goodness sense, of which the current
international finance architecture is visibly deficient.
Thus dollar hegemony is objectionable not only because
the dollar usurps a role it does not deserve, but also
because its effect on the world community is devoid of
moral goodness.
Money issued by government fiat
is a sovereign monopoly, while debt is not. Anyone with
an acceptable credit rating can borrow or lend, but only
government can issue money as legal tender. When
government issues fiat money, it issues certificates of
its credit good for discharging tax liabilities imposed
by government on its citizens. Privately issued money
can exist only with the grace and permission of the
sovereign, and is different from government-issued money
in that privately issued money is an IOU from the
issuer, with the issuer owing the holder the content of
the money's backing.
But government-issued fiat
money is not an IOU from the government because the
money is backed by a potential IOU from the holder in
the form of tax liabilities. Money issued by government
by fiat as legal tender is good by law for settling all
debts, private and public. Anyone refusing to accept
dollars in the United States is in violation of US law.
Instruments used for settling debts are credit
instruments. Buying up government bonds with
government-issued fiat money is one of the ways
government releases more credit into the economy. By
logic, the money supply in an economy is not government
debt because, if increasing the money supply means
increasing the national debt, then monetary easing would
contract credit from the economy. Empirical evidence
suggests otherwise: monetary ease increases the supply
of credit. Thus if money creation by government
increases credit, money issued by government is a credit
instrument, quod erat demonstrandum.
Hyman Minsky rightly said that whenever credit
is issued, money is created. The issuing of credit
creates debt on the part of the counterparty, but debt
is not money; credit is. If anything, debt is negative
money, a form of financial antimatter. Physicists
understand the relationship between matter and
antimatter. Albert Einstein theorized that matter
results from concentration of energy and Paul Dirac
conceptualized the creation of antimatter through the
creation of matter out of energy. The collision of
matter and antimatter produces annihilation that returns
matter and antimatter to pure energy. The same is true
with credit and debt, which are related but opposite.
They are created in separate forms out of financial
energy to produce matter (credit) and antimatter (debt).
The collision of credit and debt will produce an
annihilation and return the resultant union to pure
financial energy unharnessed for human benefit.
Monetary debt is repayable with money.
Government does not become a debtor by issuing fiat
money, which, in the United States, takes the form of a
Federal Reserve note, not an ordinary banknote. The word
"bank" does not appear on US dollars. Zero maturity
money (ZMM) in the dollar economy, which grew from $550
billion in 1971, when president Richard Nixon took the
dollar off a gold standard, to $6.333 trillion as of
June 2003, is not a federal debt. It amounts to more
than 60 percent of US gross domestic product (GDP),
roughly equal to the national debt of $6.67 trillion at
the same point in time.
A holder of fiat money
is a holder of sovereign credit. The holder of fiat
money is not a creditor to the state, as many monetary
economists claim. Fiat money only entitles its holder a
replacement of the same money from government, nothing
more. The holder of fiat money is acting as a state
agent, with the full faith and credit of the state
behind the instrument, which is also good for paying
taxes. Fiat money, like a passport, entitles the holder
to the protection of the state in enforcing sovereign
credit. It is a certificate of state financial power
inherent in sovereignty.
Topics presented at
the Seventh International Conference on Economics
included the critical examination of globalization, the
causes and management of financial crises, international
finance architecture, growth economics, labor economics
and risk management. The conference provided a venue to
exchange views on the latest thinking and recent
technical advances in economics in response to pressing
current problems and issues. For more information, visit
the conference website at http://www.erc.metu.edu.tr.
Henry C K Liu is chairman of
the New York-based Liu Investment Group.
(Copyright 2003 Asia Times Online Co, Ltd. All
rights reserved. Please contact content@atimes.com for
information on our sales and syndication policies.)
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