Rule of Law Will Cure Stockman’s “Great Deformation”

Lady JusticeLet me disclose right up front that I have not yet completely read David A. Stockman’s seven hundred page bombshell of a book The Great Deformation: The Corruption of Capitalism in America.  It arrived a few days ago and I am making steady progress, however.  From several laudatory reviews, such as that by Detlev Schlichter, I know that my blood will boil as Mr. Stockman recounts much known insults to the free market system but with an in-depth knowledge, born of successful careers in politics and business, that few possess.  It is remarkable that someone who has been so successful navigating the modern financial system can also look objectively upon its inherent corruptions.

Nevertheless, as much as I know I will enjoy (if that is the right word) reading this book, I must disclose that I do not agree with Mr. Stockman’s prescription for curing the deformation disease.   You see, I read the last chapter first.  It is titled “Another Road That Could Be Taken”.  In it Mr. Stockman lists thirteen steps that he believes will prevent the “State-Wreck Ahead”.  There is little here with which I agree.  Mr. Stockman wants to retain the Fed, albeit with fewer powers, increase regulation, change the length of the terms of Congressmen, Senators, and the President and limit them to but one term, eliminate the electoral college, retain a means-tested safety net, and confiscate thirty percent of all the wealth in the nation to pay off the debt.  On the positive side he does want to eliminate FDIC insurance and ten major federal agencies and departments, separate the state and the free market, end bailouts and subsidies, and return defense spending to that of actual defense.  His prescription relies too heavily on retaining the superstructure of the current monetary system but supposedly controlling the beast with prohibitions on its powers.  There is much naiveté here from someone who has seen so much.

The cure for the great deformation: Adherence to civil and commercial law

The cure for the great deformation is rather simple.  The core of the problem lies in the government’s control of money and banking.  These vital services must be returned to the complete control of the free market and subject them to normal civil and commercial law.  No entity would be given a monopoly on money production.  Banking would be divided, naturally by the market, into deposit banking and loan banking as described by Murray N. Rothbard in The Mystery of Banking.  The government would prosecute any money issuer or banker who did not maintain one hundred percent reserves against demand deposits.  There are some Austrian economists who posit that in a free banking environment such laws would not need to be enforced and/or should not be enforced.  A person might accept that his banker lend out some of his demand money, thus maintaining less than one hundred percent reserves.  The problem with squaring this supposedly free market rule with civil and commercial law is that the money and/or checkbook deposit is created in order to be transferred at some point to others who have no way of knowing that they might be accepting a certificate or check backed by less than one hundred percent reserves.  The essence of a sound monetary system is that the commodity itself is the money; certificates and bank book entry demand deposits are money substitutes and may be redeemed for the commodity money upon demand.  It is fraud for a money issuer to produce a certificate or demand account that claims to represent a specific weight or volume of a commodity and yet hold less than that commodity in reserve.

Civil and commercial law does not recognize special privileges for any economic actor.  A banker could not refuse to redeem his demand instruments in specie without violating the law, for which he would go to jail and have both his business and personal assets distributed to his creditors.  Keep in mind that I refer here only to the deposit banking side.  On the loan banking side, the customer is not a bailor–that is, a person who retains ownership of goods but entrusts possession of them to another under a bailment, as is the case on the deposit banking side–but a lender of funds to his banker for a set term for which he receives interest.  There can be no absolute guarantee of the return of the funds, however, since the banker lends them out at risk.  The customer’s only security is in the banker’s capital account and reputation for having exercised previous good judgment.

Privileged immunity from law made the great deformation possible

Under this system most of the abuses that I expect to find detailed by Mr. Stockman could not exist, for it is the special privileges accorded to the Fed and the banking system in general that makes them possible.  As usual Ludwig von Mises says it best:

There was no reason whatever to abandon the principle of free enterprise in the field of banking…What is needed to prevent any further credit expansion is to place the banking business under the general rules of commercial and civil laws compelling every individual and firm to fulfill all obligations in full compliance with the terms of the contract.Human Action, p. 440; p. 443

No doubt government may still find a way to bail out and/or subsidize favored industries, but it could do so only with sound money, obtained from the citizenry through taxes or the bond market.  There is a natural limit to how much can be raised from either source.  The people do not like paying higher taxes, and the bond market would require higher interest rates for increased deficit spending.  Both avenues reveal to all that resources are limited and that government cannot call them into existence but must obtain them from the private sector one way or another.  Printing money masks this irrefutable fact, leading the people to believe that government spending not only is costless but actually beneficial.  Thusly, under the current fiat money system, which was made possible by removing money and banking from the control of civil and commercial law, the Fed printed $700 billion to fund its Toxic Asset Relief Program (TARP) in 2008 and has engaged in massive asset purchases under its quantitative easing program ever since.  None of this would have been possible under a sound money and banking system.  Furthermore, the government’s bailout of General Motors at the expense of the bond holders would never pass court muster even if government could raise the billions of sound money to finance the takeover.

Adherence to law returns sovereignty to the people

Placing money and banking under civil and commercial law may not appear to be dramatic as Mr. Stockman’s thirteen points, but it would change the nature of government’s relationship to the people, restoring our liberty and placing government as our servant and not our master.  Losses would be borne by the individuals involved and not made into a social responsibility of the entire body politic, ending massive financial moral hazard.  Governments could still squander our money to some extent, but we would no longer be blind to the claim that they are doing so for our own benefit.  Sound money would reveal the true nature of corrupt practices which government now claims are necessary to stimulate the economy to recovery.  A free democracy always requires constant vigilance by the people of its government’s actions.  Placing all society under civil and commercial law is a prerequisite for such vigilance.  Patrick Barron

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