[R-G] [BillTottenWeblog] A Progressive Program for Monetary Reform?

[Bill Totten]

Examination of William F Hixson's book A Matter of Interest: Reexamining
Money, Debt, and Real Economic Growth. Foreword by John H Hotson
(Praeger, 1991).

by Robert Pollin

Monthly Review  (October 1993)


"The Casino Society" is the apt term that came to characterize the US
economy in the 1980s - the speculation driven free for all symbolized by
three of the wealthiest convicted felons in history: Charles Keating of
Lincoln Savings and Loan infamy, junk bond kingpin Michael Milken, and
arbitrage operator Ivan Boesky.

Boesky captured the spirit of the period with his famous "greed is good"
declaration as the 1986 University of California-Berkeley Commencement
speaker. Some observers have attempted to explain the 1980s as simply
due to an unprecedented and overzealous embrace of Boeskyism. But could
one seriously argue that there were significantly fewer greedy people in
previous decades? Understanding the casino society of the 1980s rather
demands that we search deeply toward an understanding of the
contemporary financial system, and in particular that we explore the
links between the contradictions in the financial sector and the broader
structural problems of contemporary US capitalism.

William F Hixson's A Matter of Interest is a stimulating effort at
providing an explanation for the economy's fundamental financial
difficulties. It is also a serious attempt at advancing policy ideas for
overcoming these problems. Hixson's analysis is notable for his creative
use of simple statistical indicators to support his arguments.

In addition, an especially striking feature of both Hixson's theoretical
and policy ideas is the way he has drawn fruitfully upon disparate
intellectual influences in developing his line of thought. These
influences range from Monthly Review editors Paul Sweezy and Harry
Magdoff to John Maynard Keynes and the leading free-market "monetarist"
Milton Friedman. Perhaps Hixson's greatest affinity is with Henry
Simons, a University of Chicago economist of the generation preceding
Milton Friedman.

According to Hixson, the basic problem with the US economy is that, over
the post-Second World War period, it has become increasingly dependent
on debt to finance government. For example, Hixson shows that in the
mid-1960s about eight cents of every dollar of total national spending
came from borrowed funds. By the mid 1980s, sixteen cents of every
dollar of spending came from borrowed funds. As Hixson shows, this rise
in debt financing also means that interest payments as a share of total
spending have increased dramatically. Observing these postwar trends, he
writes that the only possible conclusion is that from 1947 to 1987 the
economy was operated in a way in which there is no hope whatsoever that
it can continue to operate for many more decades, and quite possibly for
many more years. (page 177).

What are the forces that have produced this unsustainable trend? Hixson
cites two main factors. The first is the Federal Reserve's use of high
interest rates as a policy tool for maintaining price stability - that
is, its policy of raising interest rates for the purpose of slowing the
economy's growth and thereby weakening inflationary pressures. The
second factor is the increasing reliance on borrowed funds by the public
and private sectors to finance both their long-term investments and
their ongoing operating costs.

Hixson argues that the logic underlying each of these developments is
seriously in error. In his view, using high interest rates to slow price
inflation only produces higher interest payments and higher prices. This
follows from the obvious point that higher interest payments must be
absorbed by nonfinancial firms as a cost. When these firms' interest
burdens rise, in Hixson's view, they will aim to mark up their prices to
reflect their additional cost, just as they would want to mark up prices
due to an increase in wages. Hence, the Federal Reserve's use of high
interest rates as an anti-inflationary tool has the perverse effect of
both increasing prices and maintaining interest rates at an excessively
high level.

With respect to private debt financing, Hixson draws on the work of
Henry Simons to argue that, to the maximum possible extent, corporations
should be financed through equity rather than debt. Simons argued that
debt financing creates a danger of "pervasive, synchronous, and
cumulative maladjustments", while also providing excessive revenues to
rentier bondholders. Simons thus favored "making a risk-taker and equity
investor out of the rentier" and Hixson endorses the idea. Actually,
Simons believed that corporations should be fully financed through
equity funds. But recognizing the impracticality of this idea under
modern circumstances, he proposed drastic simplifications in the types
of debt and equity instruments that corporations could issue. As Hixson
emphasizes, one crucial result of such a restructuring of corporate
financing would be to substantially reduce the ratio of interest
payments to national income.

Hixson's most dramatic and fully argued proposals concern government
financing. Hixson contends that the federal government should not engage
in deficit financing at all. Rather, governments should exercise the
power they possess to be the sole creators of new money. In periods of
high unemployment when the economy needs stimulus through government
spending, the government should therefore finance its spending entirely
through money creation rather than borrowing. This way, the return on
government projects are essentially infinite: employment and income will
increase at no cost, since the government has the power to create money
costlessly through its central banking operations. Moreover, the
government would be free of debt, and we the taxpayers would no longer
be paying fifteen cents on every dollar of our federal taxes to cover
interest payments on the debt.

There is an important corollary to this proposal, discussed at length by
Hixson. This is that the private banking system should be completely
stripped of the power it now has to create money. The way the banks
create money is through the system of fractional reserve banking. In
this system, banks accept private deposits with the understanding that
depositors are able to get their money back when they want it. Therefore
such "demand deposits" are as good as money, and in all standard
measures, are counted as a portion of the money supply. However, under
fractional reserve banking, the banks also have the right to lend out
most of the deposit funds they have received. If they receive $10 in
deposits, they can, for example, lend out $9 in loans. This increases
the money supply from $10 to $19, since the loans can be spent by
borrowers just like cash or a check of a depositor. The beneficiaries of
this money growth are the banks, who receive interest on the loans they
made.

Note that this whole system is premised on the idea that the original
depositor is unlikely to come back to the bank and demand her $10, even
though she has the fight to do so. If a high proportion of depositors
did, at the same time, decide they wanted to convert their deposits to
cash, the bank would simply be unable to accommodate this demand, and
financial panic would ensue. The Federal Deposit Insurance Corporation -
deposit insurance that is government guaranteed and thus underwritten by
taxpayers - was created in the 1930s precisely to avoid such panics, and
thus maintain the viability of a fractional reserve system.

Under Hixson's proposal, banks would be obligated to maintain 100
percent of the deposits they receive in their vaults. In other words,
they would no longer be lending institutions, and as such, they would no
longer have the power to create money through privately profitable
activity. This would also eliminate the need for taxpayer supported
deposit insurance.

Lending institutions in Hixson's scenario - providing credit primarily
for mortgages and small businesses - would make loans with the deposits
they accept. But a substantial waiting period would then be required
before depositors could withdraw their funds from these institutions.
This would make deposits from these institutions essentially illiquid:
they could not serve as a source of money or "near money" alternative to
that supplied by the government.

Overall then, Hixson's proposals aim to promote far less reliance on
debt, fewer opportunities for speculation, and, most broadly, drastic
simplification of the US financial system. These are obviously desirable
ends. The question is whether Hixson's proposals are a viable vehicle
for achieving them.

At the level of theory, Hixson has overstated his case on some crucial
points. One example concerns his claim that a Federal Reserve policy of
raising interest rates is actually inflationary, rather than
deflationary, as standard theory would hold. In fact, either case is
possible, depending on whether interest rates are pushed up high enough
to stifle borrowing and spending. Certainly, during former Federal
Reserve Chair Paul Volcker's famous "monetarist experiment" of
1979-1982, raising short-term interest rates to nearly twenty percent
did manage - albeit at tremendous human costs in both the US and in
particular the Third World - to wring inflationary pressures out of the
economy, just as he intended.

At the level of policy, an immediate question about his approach is
whether, in the contemporary highly innovative and flexible global
financial market, it is realistic to assume the US government, or any
government, could successfully thwart the creation of highly liquid
deposit funds - that is, substitute forms of money or near money -
generated by the private financial system. A central goal of financial
innovators over the past thirty years has been precisely to create
assets for depositors that are at once highly liquid but that also
provide their holders with positive rates of return.

A formidable act of political mobilization would be needed, in other
words, to return to a financial environment that is not driven by
innovation and circumvention of government regulations. And even
assuming that such a political mobilization were attainable, we would
then have to question whether its efforts should be concentrated, as a
first priority, on a Hixson-like agenda of reform.

One basic problem with his approach is something that monetarists would
pounce on, and here with some reason. There is a real danger of
excessive inflation ('too much money chasing too few goods') if
government relies exclusively on creating money to finance its projects
beyond a level supported by its tax base. The first way to prevent
excessive inflationary pressures is the monetarist alternative, which is
to strictly limit the growth of money. This obviously would inhibit
government spending, which is exactly what monetarists favor. The other,
more difficult, but also more politically progressive option would be to
ensure that the government projects funded by the newly created money
are bringing productive assets onstream at a rate equivalent to that of
money growth (goods and money growing together). In other words, a
crucial component - even more central than the financing mechanism
itself - of a progressive financial agenda would be to create an
effective system of credit allocation for channeling funds into projects
that promote productive activity and sustainable development.

Once the issue is posed in this way, we are then forced to consider what
would be the best institutional forms for promoting a more rational
allocation of credit. Who should be in control of the central bank? How
might we change the allocation of pension funds - which now supply more
than half the total funds to the US capital market - so that this money
is used to promote the overall well-being of workers, not merely the
highest short-term rates of return for the funds? In my view,
progressives need to resolve such questions first before taking on a
financing mechanism that could, in the absence of a rational credit
allocation plan, degenerate into a monetarist tight money regime or a
similarly unsatisfactory condition of unproductive spending and
excessive inflation.

Given the ongoing irrationality of our financial system, a program of
progressive restructuring could become politically feasible in the
foreseeable future. Regardless of how one responds to the details of
Hixson's proposals, A Matter of Interest is a serious attempt to grapple
with the issues before us. As such, it should become a useful resource
in building both the economic understanding and political will necessary
for constructing a more equitable and viable financial system.

Copyright (c) 1993 Monthly Review Foundation, Inc.
Copyright (c) 2004 Gale Group

http://findarticles.com/p/articles/mi_m1132/is_n5_v45/ai_14280625


TO POST A COMMENT, OR TO READ COMMENTS POSTED BY OTHERS, please click
on the word "comment" highlighted at the end of the version of this
essay posted at http://billtotten.blogspot.com/