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Section 1: diagnosis - the principal causes of the major problems faced by the American economy.

The inconvertible paper dollar

Without any exaggeration, it can be said that the No. 1 enemy of the American economy and implicitly of the American people is the inconvertible paper dollar.

According to the theorem of the natural parameter of the numeraire (see Appendix), any inconvertible paper currency represents anti-numeraire, i.e. a disequilibrium type of money which has inherent instability that cannot be corrected by any government policies. If we examine the monetary and financial history of the USA or any other modern country, there is not one single instance where the veracity of this theorem has not been confirmed time and again.

The monetized debt or credit by private banks

Unfortunately, only an unbelievably small number of Americans can understand, or even envision, that the No. 2 enemy of the American economy lies in the monetization of credit by private banks.

According to the theorem of the natural parameter of the numeraire, monetized credit represents another form of anti-numeraire or a disequilibrium type of money which has inherent instability that cannot be corrected by any government policies. In fact, judged in quantitative terms, the private banking system takes the position of public enemy No. 1 since private banks with the support of the Federal Reserve System provide 85 per cent or more of the supply of money in circulation, in the form of abstract or nominal purchasing power known as demand deposits.

Of course, it is correct to say that private banks help business to expand and create jobs. In this sense American banks provide valuable services to their customers, including the government. But this is only a half truth, since banks through the monetization of credit create inflation and deflation, also, i.e. instability and social inequities on a large scale for which there is no immediate cure.

Again, on examining the financial history of the USA or any other country in modern times, there is not a single case where the government or the central bank, or both together, were capable of controlling the issuance of bank credit in such a way that the problems of financial instability and social inequity were resolved satisfactorily. In this argument one must have a clear distinction between first, real, i.e. equilibrium type of credit used in business (in the form of money, commodities and services) which is granted within the limits of the existing volume of real income in the economy and therefore does not change the supply of purchasing power in circulation, and second, nominal (artificial), i.e. disequilibrium type of credit monetized by private banks and which implicitly changes the supply of money in circulation. The implication is that only the latter form of credit can be inflationary or deflationary.

This problem is extremely serious today because American banks, through the practice of monetizing credit, are creating not only domestic but also international inflation of dollars. In this way an unprecedented double inflation is attacking the US economy from two directions making it impossible to conduct rational and successful policies.

The Federal Reserve System cannot fulfil its statutory functions

The President of the United States, members of Congress and the general public believe that the Federal Reserve System has adequate tools to control the supply of money in circulation. Failures are envisioned to be the result of unwise decisions by the members of the board of governors.

The Federal Reserve Act of 1913 and its Amendments empowers the Fed to raise or lower the official discount; to change within certain limits the legal reserve requirements for private banks; and to buy or sell government securities, depending whether the economic conditions are under pressure of an inflation or a deflation. These are the main tools available to the Fed to effect monetary policies.

Unfortunately, the Federal Reserve Act does not say anything about further requirements necessary to be able to apply these tools successfully. Indeed, these tools have little value, and can be misleading, if we do not have some objective and reliable standards to measure the right time for their use and the proper size of intervention. The discovery of such reliable standards is, however, impossible as long as we do not have the exact mathematical formula to calculate and the institutional means to reinforce the equilibrium supply of paper money (Federal Reserve Notes and Deposits) and monetized bank credit by private banks, at any given moment. The inherent instability of anti-numeraire in the form of paper money and monetized bank credit makes impossible the successful use of such a formula, even if invented.

The Federal Reserve Act of 1913 provided only a 35-40 per cent gold backing or numeraire-currency and the rest - 60-65 per cent - was the unstable or anti-numeraire type of money. The original deficiency for the troubles of today, therefore, goes back to the monetary act of 1913. Such a mixed monetary system where anti-numeraire prevailed could never function properly. The many instability problems between 1913 and 1971 confirm without question the veracity of this statement.

The amendments of 1945, 1965 and 1968 to the Federal Reserve Act have reduced the percentage of gold backing, i.e. of numeraire to 25 and then to 0 (zero). Why should the USA move from a 40 to 25 and then to 0 (zero) per cent stable, equilibrium currency? This is an interesting question that future historians must answer in greater detail. For the moment the best answer available is that it was done in the name of, and to satisfy, the Keynesian doctrine which proclaimed that "money does not need to be covered by gold" or another suitable commodity. This is, however, the same as saying "money can be anti-numeraire", because - according to Keynes - it can be managed satisfactorily by government, specifically through monetary and fiscal policies. Whether we like it or not, this shows how strong the influence of Keynes was upon the thinking of our time, and still is. But the problems in question with all Keynes's influence were not resolved by far.

Both the American and the British experience (and that of other democratic countries) between 1934 and 1997, and especially after 1965 in the USA, proved beyond any shred of doubt that the government together with the central bank cannot successfully manage paper money and monetized bank credit. This represents a crucial experiment in science and shows a glaring contradiction between what the Keynesian doctrine promises and its application in real life. Yet, the American Government and the Federal Reserve System insist in prolonging the application of Keynesian policies which can lead nowhere but to total financial and economic ruin of the country. This is the best preparation for a totalitarian regime (regardless whether of the right or of the left) which usually comes as an aftermath of unresolved social and economic conflicts.

In brief, the Federal Reserve System has been faced with insoluble issues since 1913 and has faced even more complications since 1965. Indeed, over this long period of time, the Fed was struggling, without any chance of success, with the Impossibility Theorem (2) (see Appendix, p. 514).

The high officials at the Federal Reserve System must acknowledge sooner or later that according to their experience there is no way to avoid or to "beat" the impossibility theorem (2) as defined in the Appendix. The sooner this public acknowledgment is made, the better for the country and for the Fed itself. It will mean that we can finally start to think of other workable methods of resolving our financial and economic problems.

The ever-rising national debt

The national debt has reached the staggering amount of $752 billion by 1978 and the Carter administration has asked Congress to raise this temporary limit by another $119 billion. (The Wall Street Journal, 7 February 1978.) The interest paid by the US Treasury just to prolong maturing debt has climbed in one year to close to $50 billion, without paying off anything on the principal. On top of this situation, to have a deficit in the public budget of $60 billion in one year and to repeat the same deficit the next year, as the Carter administration plans, is not consistent with healthy economic and financial conditions and does not provide a good platform of optimistic expectations for the future. The meritorious goal of President Carter to achieve a balanced budget by 1981 has now vanished and is no longer mentioned. This should not be interpreted as a one-sided criticism of the Carter administration because the record of previous administrations on this issue is not any better. Only the figures are getting bigger and bigger because more and more of the national debt is maturing.

It is amazing to see how easily, and without serious debate, members of the US Congress have approved and continue to approve the increase in the national debt ceiling whenever an increase is requested by the Secretary of the Treasury. It has become simply a routine matter, as if no serious dangers were involved in this practice. Again, this is a sign of the strong influence of Keynes, who proclaimed that government deficit-spending was a necessity during times of unemployment and that a rise in the national debt was no problem as long as it was held in domestic hands.

The falling external value of the American dollar

In recent years, almost every other day one could read in the newspapers that the US dollar has fallen to record lows against other major European currencies and the Japanese yen. Recently it was estimated in some places that 300 billion and in other places 500 billion US dollars were in foreign hands (1978).

On Tuesday, 28 March 1978, the Bank of Japan, in an attempt to support the American dollar, purchased more than $1 billion, but the exchange rate for the dollar still went down on that very same day because there was no buyer interested in dollars; only holders of dollars rushed to unload them (The New York Times, 1978). The frustrated Prime Minister Takeo Fukuda declared the following day that Japan could not repeat this kind of intervention. Then in the following days and weeks the US dollar continued to go down. But how long can the external value of the dollar fall without creating irreparable damage to the American economy itself, already struck by a double inflation - one from within and the other from abroad?

Back in 1965 the amount of US dollars in foreign hands was estimated at $20$25 billion. Between 1965 and 1971, the USA effectively lost more than $5 billion gold, or one-third of the gold stock at Fort Knox. In August 1971, President Nixon, instead of cleaning the financial house, suspended the convertibility of the dollar and opened a Pandora's box with an international inflation that now endangers the entire free world with another financial and economic collapse reminiscent of the 1930s.

The Keynesian theorem that "money does not need to be covered" is definitely false, if we want to have stability from within. Money needs to be 100 per cent backed by gold or any other suitable commodity in order to become numeraire and thus be able to serve as an objective and reliable instrument for economic calculation, regardless of the social, economic or political system and regardless of whether we refer to a national or international economy.

Pure speculations in organized securities, commodities and foreign exchange markets

There exist tremendous disequilibrium forces in the organized securities commodities and foreign exchange markets. These, in conjunction with the monetization of credit by commercial banks, compound the present day problems of the American economy. These disequilibrium forces have remained unnoticed by the general public because economists do not yet recognize the lack of a clear distinction between the following two different kinds of transactions as a problem.

On the one hand, there are natural, real or equilibrium transactions whereby people save money from the current stream of real income and invest it directly in securities or foreign exchange. The same thing is true when a company uses similar funds to buy commodities or raw materials necessary for manufacturing. These are genuine or real investments which do not create but, on the contrary, resolve problems of a national economy. The law of supply and demand applies thoroughly to this kind of transaction and the normal, Marshallian demand and supply curves determine equilibrium or stable prices.

Unfortunately, the expected equilibrium prices within the mixed structure of the organized markets of today never materialize because, at the same time, other disequilibrium forces come into action through a second, entirely different, type of transaction.

Simultaneously with the preceding, there are also artificial, nominal or disequilibrium transactions in the form of pure speculations. In these there is no genuine, real investment, since the buyer has no need and no intention to really purchase the specific stock, commodity or foreign exchange. The object of these trades is entirely different from the first type of transactions. The buyer here is simply betting that the price will go up. Consequently, he places an order to buy with the hope to sell later at a profit. The seller, on the other hand, has no intention of concluding a real transaction. He is just betting that the price will go down. Thus, he is selling now with the intention of repurchasing later at a lower price and thus realizing a differential profit.

This kind of "make believe" business actually represents "institutionalized gambling". It is practiced daily within the organized markets and on the over-the-counter markets. These are pure speculations which disturb the natural course of the markets. The normal Marshallian demand and supply curves in this case appear inverted and the law of supply and demand does not work to produce equilibrium prices (see Appendix, p. 520).

The complications of this issue emerge from the fact that, under present prevailing conditions, we are unable to segregate natural (equilibrium) from artificial (disequilibrium) transactions. Pure speculation in the form of trading in "futures" or "options" can be easily determined and legally forbidden, as did the Commodity Futures Trading Commission recently on a small scale as a result of a scandal involving the Boston Commodity Options firm of Lloyd, Carr & Co. The time element in a pure speculation, however, can be reduced to 24 hours or less and thus the same problem exists in regard to most daily transactions on these markets.

Why are pure speculations harmful to a national economy? First, because they nurture instability by inducing artificially higher or lower prices than would exist under conditions of stable equilibrium. This instability in the organized securities, commodities and foreign exchange markets inevitably carries over to the rest of the economy. Second, those involved in pure speculations (from the little guy who borrows from a bank to make an extra buck to the wealthiest people in the nation who want to make additional millions, including powerful financial institutions like mutual funds, trust funds, pension funds, etc.) hold daily a huge amount of funds (tens of billions) to carry on this kind of "make believe", but profitable, business at the expense of the rest of the economy.

This is very disturbing when we remember that these tens of billions of dollars could otherwise daily be used in productive investments to create more employment and more real income at a time when unemployment is so high and the government and the people need more income.

Monopolies, oligopolies and multinational corporations

In America and elsewhere there is a problem of big business and big finance. Very often, however, this issue is blown out of proportion or confused by believing that all big business is a social evil. The fact of the matter is that per se big business is not a social evil. This may occur only when it takes a certain monopolistic form (cartels, bank holding companies) or is artificially expanded beyond a certain limit. The question is, where is that limit? For this answer we need to distinguish between: Natural, legitimate concentration of economic power, i.e. a normal increase in the size of business for productive use, which has a precise limit - the optimum level of output at the least cost of production, and artificial, illegitimate concentration of economic power, i.e. an abnormal increase in size of business for the sole purpose of building up monopoly power and thus reaping an extra profit. The latter case happens under conditions of disequilibrium in capitalist as well as socialist countries. A monopoly price (on a private or public basis) is always higher than an equilibrium price and is, therefore, in both cases socially harmful.

Multinational corporations and public utilities exercise both types of economic power. Some of their activities are natural, legitimate and consistent with equilibrium prices but, at the same time, other activities are inconsistent with conditions of stable equilibrium and create grave problems of social inequity and economic instability. Today we do not have reliable instruments to measure the dividing line between legitimate and illegitimate business growth.

Tomorrow, the complex issue of monopoly power and monopoly profits can be finally and effectively resolved through the introduction of conditions of stable equilibrium and a code of ethics in business requiring that all transactions be concluded at equilibrium prices where only a normal, legitimate or equilibrium rate of profit is included.

The labour-management relations

While labour unions do present a problem for the American economy, we should be aware that, like big business, they are not per sea social evil. Indeed, labour unions today have certain legitimate rights of association to pursue the welfare of their members but, at the same time, the means they often use to achieve these goals are illegitimate in the sense that they are harmful to the rest of the economy and the nation. In more explicit terms, the unions are making use of monopolistic practices exactly as does the management of many large corporations, with the difference that the first are permitted by law while the latter are not.

A vicious circle exists in this issue which cannot be broken unless the American mixed capitalist system is reconstructed according to conditions of stable equilibrium. Then labour unions will be included under the same roof of stability and equity through a "code of ethics in business and labour" which will outlaw monopolistic practices and monopolistic profits that lie at the heart of the issue.

Abuses and dangers in the welfare state

The welfare state was conceived after World War II as a fall-out of the same Keynesian economic philosophy, namely, that the government can indirectly manage the distribution of national income in such a way as to reduce poverty and social tensions to a minimum. Of course, to think about a programme to help those in need represents a noble act.

The United States Government has tried hard during the last decades to achieve this noble goal in practice. New slogans were even coined during the Johnson administration: "The War on Poverty" and "The Great Society". The budget on welfare now [1978] surpasses $100 billion without at all diminishing poverty and the extent of social tension. In fact, the distribution of the national income in the USA over the last four decades has not changed much, which means that the disequilibrium forces in the system are perpetuated.

What went wrong with the welfare state in practice? Nobody can deny that the USA, like other capitalist and socialist countries, has a social problem of poverty. There are millions of Americans who for some reason are not able to earn a decent income or who have substandard incomes. Instead of systematically investigating the real reasons why these millions of mature people cannot earn an adequate income and then immediately eradicating those causes, the government found it more convenient (political patronage!) to hand over to these unfortunate people a certain amount of nominal income in the form of inflated money. This was a patented disequilibrium solution which did not extricate but on the contrary perpetuated and even expanded the roots of poverty.

The welfare benefits, after some temporary relief of immediate needs, have inflicted two negative effects upon the poor people themselves. First, because of the aid of a minimum nominal income the number of recipients increased since they had no other productive activity but to practise the business of self-multiplication. Second, the very fact that income can be received without performance has nurtured a new philosophy of life based on the idea that society owes a living to the individual. This is a very dangerous philosophy in a free, democratic society. On the one hand, it leads to a decline in the spirit of individual responsibility which lies at the heart of a free society; on the other hand, it encourages thinking in terms of a collectivistic type of society which cannot be free. In addition, the welfare state practices have gradually created serious, insurmountable financial difficulties for the government.

Because of the welfare state or with its help, millions of Americans live a life of idleness which is morally and physically detrimental for them and not good for the future of the country. The industrious, productive segment of our population, on the other hand, cannot indefinitely support this invisible "army of the idle" financially. If the US Government does not correct the unsuitable methods used in the past and present, a social explosion is inevitable. The so-called "guaranteed minimum annual income" or the "negative income tax" belong to the same incorrect philosophy of taking from those who are industrious and giving to those who are less industrious or who do not want to work. The ideal system is one in which there is an opportunity to work and each one capable of working is required to earn his living.

Productive vs. unproductive bureaucracy at all levels of government

It hardly need be mentioned that there is inefficiency and waste at all levels of government. Basically we are faced with two complicated problems. First, Americans are proud to state at every occasion that the USA has a federal, democratic form of government but at the same time we lack an adequate legal machinery to determine the specific tasks for each level and implicitly we are missing an equitable distribution of public income among the three levels of government. In other words, the American form of government politically is federal and democratic but not from the financial and economic point of view. And this inconsistency creates problems of inefficiency and overlapping in the use of the taxpayers' money.

Second, under today's political structure there is no opportunity for a direct evaluation by the American people of government performance since there are no legal provisions requiring submitting the budget of each level of government to a referendum as exists, for instance, in Switzerland. The fact that the US Federal Government can so easily get an increase in the national debt ceiling whenever there is a deficit, clearly shows that in this way inefficiency and waste do not come immediately to the direct attention of the public; this is a serious problem.

Nobody in his right mind argues that we do not need government or that we can dispense with it completely. The same is true of bureaucracy. Scientifically, a distinction must be made between legitimate, proper or equilibrium level of government activity and expenditures, and illegitimate, improper or dis-equilibrium level of government activity and expenditures. It is also understandable that on the same basis bureaucracy can be divided into productive and unproductive, normal and abnormal.

The trouble under the existing conditions of disequilibrium lies in the fact that there is no way of knowing where the line between the two forms of government activity and bureaucracy is to be drawn. What we have now is only an ambiguous and blurred image of a beleaguered government struggling with the Impossibility Theorem (2) and moving aimlessly in a vicious circle: on the one hand the ill effects of a cumulative disequilibrium of stagflation require more and more deficit spending and government intervention, and on the other hand, the many existing problems remain unresolved and the situation becomes more and more complicated.

The perennial argument between conservatives, who are of the opinion that government should spend less, and liberals, who defend the view that government should spend more, does not provide the right platform to resolve effectively the heart of the argument. Neither the conservatives nor the liberals in America go deep enough with their analysis to touch the roots of the problems - a miscarriage of the concept of a workable and equitable free enterprise system, specifically a worn-out institutional framework distorted through inconsistent legislation passed by the US Congress in this century in terms of money, banking, finance, employment and welfare, legislation which not only does not correspond but runs counter to the ideals of a free, just and stable society and economy.

With a conversion of the present mixed unstable system to one of stable equilibrium, as recommended in this plan, the line between legitimate (proper) and illegitimate (improper) government activity can be clearly drawn. Further, it is expected that in about a year the budget of all three levels of government in America can be reduced to approximately one-third of today's levels. This information is mentioned only to indicate the enormity of the inefficiencies and waste in government all as a result of the status quo, i.e. the perpetuation of a mixed system in disequilibrium.

Of course, the restructuring of the present system into a new, stable and most perfect social and economic order, which I call "Social Liberalism", demands support by the scientific community (now a divided house) and considerable political wisdom, moral integrity and bold initiative in dealing with vested interests in government bureaucracy at all levels. Government vested interests are usually associated with certain segments of business, banks and other large financial institutions, labour unions and professional groups including experts close to the seat of power. For the moment these experts have nothing new to offer except more government intervention and planning which, under the existing conditions, means more disequilibrium and more complicated problems. The dilemma of our time is that most experts who have access to the seat of power in Congress and the Administration are recommending solutions which are in direct conflict with what the American people want or expect. No surprise that such solutions in practice never work.

A stabilization plan follows to illustrate how American capitalism, today beleaguered by so many problems at home and abroad, can tomorrow be quickly converted into a stable system. It is estimated that in about nine to 12 months full employment, price stability, a balanced budget, a maximum of social equity in the distribution of national income and a balance of payments in equilibrium can become reality and not just desirable goals as during past experiments.
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Author:Rugina, Anghel N.
Publication:International Journal of Social Economics
Date:May 1, 1997
Words:4475
Previous Article:Introduction: why the existing econometric model cannot help.
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