"The Global Economy in Transition"

Henry C.K. Liu

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. 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.

This presentation will discuss the global economy in transition,
focusing on the changing nature and role of money, debt, trade, markets
and development.

Fiat Money as Sovereign Credit

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 worldview 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.

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 nation's 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 reestablishment 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
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 US, 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 aesthetics 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 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 US 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.

Credit and Money Creation

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. 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 un-harnessed for human benefit.

Monetary debt is repayable with money. Government does not become a
debtor by issuing fiat money, which, in the US, takes the form of a
Federal Reserve note, not an ordinary bank note. 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 Nixon took
the dollar off a gold standard, to $6.333 trillion as of June 2003, is
not a federal debt. It amounts to over 60% of US GDP, roughly equals
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.

The rest of the lecture deals with how the global economy will be
structured differently if the idea that money is sovereign credit is
understood and applied, on issues such as a new international finance
architecture.

[The full text is 70 pages.]

Henry C.K. Liu