Rethinking the Foundations
(this version March 3, 2019 – cross-posted at Common Law Economics)
WANTED: an understanding of economics that takes into account the realities of economies, economies that really exist, rather than the textbook abstractions or figments of political campaigns. And really existing economies function in terms of sovereignty, property, contract, debt, taxes, corporations, etc. These are the realities that need to be taken into account – if we wish to put forward an economics of practical value.
For we first need to understand before we can act. Marx’s dictum needs to be reversed. Inscribed on his gravestone is the famous text from his Eleven Theses on Feuerbach: “The philosophers have only interpreted the world, in various ways. The point, however, is to change it.” No, we first have to interpret, to understand, before we go about changing things. After all, it is far easier to destroy than to build.
Choice: The Cornerstone of Contemporary Society
I don’t think I’m saying anything controversial if I state that the defining characteristic of contemporary society is the opportunity it provides for choice. For better or worse, choice defines our times. This is most basic reality that economics must take into account.
As such, we live in a society in which we are free to choose. What does this mean? That we work toward goals of our own; in fact, from childhood we are taught to seek out and pursue such goals as we ourselves believe will offer us fulfillment. We see this as the way things are, sometimes even as burdensome, when our choices prove wrong ones, or incapable of fulfillment, or perhaps turn out to yield something other than we thought when we embarked upon them. The capacity to make choices is inherent, but the framework within which such choices can even be envisioned, much less realized, is itself a cultural artifact. It is the product of generations of struggle and conquest; and it requires conscious cultivation to be maintained. This is our inheritance – the free society. Its burden is precisely its freedom.
A free society is composed of individuals and associations who, because free, are not subsumed in the pursuit of a common goal. Rather, they pursue goals of their own choosing. To this end, because each needs the services of the other in order to attain their goals, their activities require coordination; and this coordination is provided by the rule of law. Behold the self-centered, self-seeking society – but it is only this if one wishes to look disparagingly at people pursuing their own self-chosen goals rather than goals foisted upon them from above. These free actors require coordination and integration, not subordination and imposition. It is this which the rule of law – what is known as common law – provides.
Real-World Law and Economics
Therefore, to understand economies, we need to understand some basic principles of law. The first such is the principle of sovereignty.
Sovereignty is the sheet anchor of a free society, of which it truly can be said, “the buck stops here.” Sovereignty is the final earthly authority, beyond which there is no appeal, bar open war. Sovereignty is the final arbiter in all conflict; its verdicts cannot be gainsaid.
First and foremost, sovereignty is adjudicatory. It adjudicates disputes; it decides cases. It mediates by applying principle to specific situations. The actions leading to these disputes it did not dictate; it only acts when asked to – but when it acts, its decisions are binding. Its decisions serve as ineluctable signposts – precedents – pointing the way to future behavior and expectations. This is the principle of binding adjudication. The law is the outgrowth of these decisions over time. This law coordinates the activities of free actors spontaneously going about their business, who require such coordinating law and adjudication, rather than direction from above.
Such a social order is not a natural product, but an artificial one. It is an ordering of things in many ways unnatural, which is why its existence cannot be taken for granted. It rubs against the grain, because it denies the communitarian urge to absorb the disparate activities of individuals into a common purpose.
In fact, this order arose through the gradual displacement of communitarian bonds by bonds of its own, bonds themselves invisible, yet which tie each and every individual together in an inextricable web, a web far more intricate and faceted than the banal monolith of primitive community. It might seem odd that the free society, where each goes his own way and pursues his own dreams, develops a network of bonds of such complexity and depth: but such is the price of freedom; and freedom cannot be maintained apart from them.
Bonds of Subjection, Bonds of Freedom
Communitarian bonds are basically of two sorts. There is the tribal bond: the primitive tribe, sib, or clan, which has at its heart the bond of solidarity based in kinship, whether real or artificial (adoption). It is primarily custom that holds sway here. The scope for individual decision, even on the part of the leader, is restricted by tradition, and the bonds of reciprocity are maintained without reasoning. Economic activity is thus geared toward maintaining the condition.
Then there is the feudal bond (broadly speaking, including both vassalage and serfdom), where, although custom still plays a significant role, the will of the lord is, in great degree, law. Here the arbitrary will of the lord determines much of the content of the bond. Economic activity is geared toward providing for the lord, especially in his role as knight.
These forms of community are distinguished by the lack of individual freedom. The individual is subordinate to the group, and does what it is given him to do, either by custom or by command. The group itself is the primary thing, existing mainly to sustain itself, mainly in opposition to external groupings. There is a decided bias toward the familiar as opposed to that which is outside – to the stranger. Communication between groupings is restricted if not virtually blocked.
New forms of bonding were required to overcome this autarkic form of life. These forms are what enable a free society to function.
To understand them, which is to understand what it takes to maintain a free society, one must first understand what it is that kept people shut up in these monolithic groupings in the first place. Why is it that people were under the impression that they needed to separate off into closed communities?
The answer is, security. People were simply not safe facing the world on their own. They could not maintain their livelihoods on their own power. They therefore formed, or were subsumed into, communities, which constituted a barrier to the threats emanating from the outside world. These threats were not, in the main, natural, but rather the threat posed by violence from other people.
These peoples were withdrawn, closed up into themselves, putting up walls up to that which stood on the outside. Within those walls was the peace which – by virtue of those static bonds of solidarity and hierarchy – communities provided to their inmates. Some sort of peace between these communities was indeed the first object of the incipient common-law order.
The Common-Law Order
And here is where common law becomes visible. There is a need for a uniform, universal law to transcend closed communities, a law integrating communities into larger, pluralistic societies, into a common order.
The task, then, is to erect a means of establishing security without the overriding subordination and dependence involved in exclusively internal group relations. Within the group, the problem does not come up, because the group resolves conflict by imposing resolutions from above, and by directing activity in such a manner as to eliminate conflict before it arises, or at least minimize it. This is how security is established by an internal regime. But a common-law order establishes an external regime whereby conflicts are resolved without subordinating the parties and without eliminating independent activity, rife as it is with opportunities for collision.
The first order of business toward the establishment of this pluralist order was the move to obviate the need for war between groups in order to obtain redress of grievances. Composition – a form of arbitration – was substituted for the feud, in which matters are settled by force.
What was going on here? A wrong had been done, cross-border, as it were, setting up an imbalance requiring settlement. This is the original, involuntary, transaction. Composition was the means for settling the imbalance. The wrong was atoned for in one way or another satisfactory to both parties.
Hence the first form of transaction was redress of grievance. As stated, this is an involuntary transaction, for one of the parties was not a willing participant. Be that as it may, it established the grid by which the settlement of transactions could be settled. This is the first iteration of the state. The state is firstly the instrumentality through which settlement between parties is achieved and maintained.
First Security, then Property
Using this initial machinery, another form of transaction became established: the voluntary transaction. Voluntary transactions are first conducted by those positioned to act outwardly, hence those atop the group (such as chieftains or feudal lords). These primeval voluntary transactions still had to be clothed in the dress of a wrong which needed to be righted, one reason why early legal institutions resorted to legal fictions. For a wrong is a trespass, a debt, a shortfall which must be made up. In the voluntary transaction, the shortfall establishes relationships, not of crime and punishment, but of credit and debt.
To secure such arrangements, thus to ensure satisfaction for non-performance, the institution of security (collateral) was established, whereby possessions were pledged as surety. Here we have the origin of the institution of property as opposed to mere possession. This distinction, fundamental to legal science, is for the most part ignored in economic science, one reason there is so much confusion on the subject, and why there is a divorce between economic theory and financial theory.
In the institution of property, possession is put to the service of transactions, over and above its use. For instance, land that is mortgaged is still capable of being tilled; but a new layer of utility has been added to it, that of collateral. Property is thus possession-plus. Property was established in the first place as an institution in service of these voluntary transactions of credit and debt (contract).
The legal distinction between property and possession is crucial to understanding the difference between command economies and free economies. Possession is what most people think of when they think of property: the physical holding and utilization of an object. It obtains in all the various kinds of economy. As such, a role for exchange can be found in all economies, where this possession is exchanged. This is not the dividing line between, e.g., “socialist” and “capitalist” economies. The dividing line is between possession and property. Property entails more than exchange. It entails the capacity to encumber, to pledge that which one possesses, without yielding up the possession and use of it. Property is thus an invisible dimension attaching to possession. Its importance is precisely in its service to contract, to credit and debt. Aye, there’s the rub.
Legal history shows the development of all these institutions developing in tandem, causing the breakup of monolithic groups. It shows the growth of common law, the law of citizenship, property, and contract, as the growth of institutions fostering communication on the basis of security. The transaction develops in its various forms, first the involuntary, then the voluntary, which in turn divides into the various forms of contract ranging from sale and purchase through pledge and debt, with property, as opposed to possession, arising in service to credit/debt arrangements.
And so the web of commitments established through voluntary transaction – contractual obligations – begins to envelop and penetrate the hitherto monolithic community groupings. This brings about the gradual breakup of these communities, as their purpose is absorbed by ever more specialized associations, pursuing individual goals, yet able to join forces in the common purpose of the general welfare by virtue of these institutions of the common law.
Therefore, there is such a thing as common-law economics. This form of economics recognizes that what comes first is the web of obligations which signal the switch to a free society, where monolithic community has been broken up, replaced by the principle of association. These obligations are reciprocal, and take the form of credit on the one side and debt on the other. It is the capacity to engage these obligations, requiring voluntary commitment and the capacity to fulfill such commitment, which makes for the economic potency of the common-law regime: they make it possible to convert time itself into a calculable phenomenon.
Contract pins down human action in time, and ties it to a money value, thus enabling it to be set against other options. It is about pinning down performance in such a way that planning becomes possible. This is the meaning of credit and debt. Thus, the stuff of economics is not in the first place goods and services. These are components of the more all-inclusive category, contract.
Traditional economics has an entirely different starting point. Traditional economics revolves around the exchange of goods and services. Its message is simple: remove all impediments to exchange between owners, and the economy will function best. Where owners are free to retain the proceeds from such exchanges, it will motivate the entrepreneurs (producers or middlemen) among them to bring goods and services to the market which otherwise would never make it there, thus spurring economic growth and advance.
Impediments firstly consist in transaction costs, which are the costs of doing business, or of buying and selling. The main point here is to facilitate the exchanges. Barter is a very cumbersome and inefficient manner of exchanging, so money is brought in as an expedient to make the process of exchange as painless as possible. Money is simply “the most marketable commodity,” a good which physically is easily exchangeable and which itself enjoys a relatively steady demand and, therefore, value (it is thus physically a durable, not quickly perishable good). With money in operation, exchange can be carried out on the scale necessary to provide for a burgeoning marketplace.
All of this could in theory be carried out in absence of any coercive apparatus of law enforcement, i.e., the state. The laws involved here are simple rules of conduct which are virtually self-evident: do not steal (i.e., the sixth of the Ten Commandments), and keep your word (i.e., the Roman-law principle pacta sunt servanda, agreements must be kept).
But, since people do not keep these simple rules but rather infringe them when it is to their advantage to do so, the apparatus of coercive enforcement enters in. The role of the state is simply to enforce these rules in the particular shape they take in a particular society. But the power of the state can then be used to make the state itself a vehicle for violating the very laws it was called into being to protect.
There are two basic ways the state can be used to violate these rules. Firstly, it can enforce laws by which specific groups are privileged in the conduct of their business. These groups can then buy and sell their goods and services at a rate which the unfettered market would not support. Secondly, taxation can be used directly to redistribute wealth away from the owner of that wealth to some other party favored by the power-holders in the state.
For this reason, the state is viewed as a necessary evil, which, if it were possible, it would be better not to have at all.
There is much to recommend in this traditional viewpoint of economics – as far as it goes. It embraces self-reliance, and that is a good thing in itself. The problem is, it does not go far enough. It does not embrace the full reality of a modern economy, nor does it quite answer to the requirements of a free economy in general. This is because, on the one hand, it presupposes quite a bit. It assumes a Robinson Crusoe-esque state of nature wherein property-owning, contract-engaging individuals coincidently meet and arrange affairs in a kind of vacuum. On the other hand, it neglects and/or misconstrues credit/debt relations, which are crucial to understanding what modern economies are all about. And because it leaves out credit and debt, it cannot answer the anti-capitalist critique of credit and debt. Hence, it is blindsided by the visceral resistance the free economy evokes, which at bottom revolves around credit and debt.
…versus Commitment Economics
What traditional economics lacks is insight into the fact that it is not exchange of goods which is at the heart of an economy, but the engagement of credit and debt. This is commitment, but commitment of a specific kind, contractual, freely engaged, limited to what is stipulated, to what Commons referred to as a “releasable debt.” It is this which is at the core of the free society and economy, and what distinguishes it from tribal solidarity (with its customary reciprocities) and feudal or command economies (with their top-down command-and-control). These commitments are what hold the free society together, what enable each of the individuals and associations to function independently yet interdependently, what enables the whole, indeed, to be greater than the sum of the parts.
Money, Credit, and Banking: Capitalism in the Flesh
Such commitments, where credit and debt are the order of the day, require the institution of money. Here we have one of the great divides between the common-law understanding of economics and the traditional understanding. What is money really, what is its purpose, what is its effect? Traditional economics has no place for money as a separate institution in its own right. Rather, money is simply another commodity, another tradeable good, but one which exceeds others in marketability and so serves to facilitate transactions. Because it is used so extensively as a means of exchange, it comes to represent value, which comes to be expressed in terms of it. Rather than, for instance, a pair of shoes being worth two hours of labor, it becomes worth $50 – as are, in this instance, the two hours of labor. But in playing this role, money needs to be as invisible as possible, needs to have as little effect of its own as possible. In this manner it fulfills the function of facilitator of transactions. These transactions in themselves lie behind the so-called “veil of money.”
But common-law economics has an entirely different understanding of money. Because of the central role it assigns to credit and debt, it sees money as the counterpart to these transactions. In this view, money is the universally accepted means by which debts are cancelled. It is an extension of the institution of contract.
Money is created through credit/debt relations between borrowers and banks. Banks are simply those institutions in society vested with the authority, granted either by custom or decree, to issue money. This transaction, stripped to its bare essentials, is as follows: a property-owner wishes to obtain the means for carrying out transactions. He does so without relinquishing his property, for the bank has no desire to buy it – it only wishes to earn the interest it can gain on the loan. Because of this, the property-owning borrower can “have his cake and eat it too.” He borrows from a bank the generally recognized medium by which transactions may be engaged and settled – dollars, euros, what have you – and he does so at the expense, not of his property, but of the pledge of his property, in case he does not repay the amount he borrows. His property stands as surety for the loan. The bank issues this medium of engaging transactions, this money, to the value of the surety, of the collateral put up by the borrower. Hence, what this money represents is the value, not of the property of the issuer, but of the borrower. And this yields a conclusion of the highest importance, simple though it sounds: money represents the value of the security; its backing is the collateral.
The Role of Precious Metals
In simpler (i.e., less secure) times, the money issued is itself a form of property, usually one of the precious metals. Gold and silver, since time immemorial, have served this purpose.
Because gold and silver have value in their own right, a value which is universally recognized, they could serve as money. But how they did so indicates this underlying reality: it was not their exchange value that counted – in other words, not their characteristics in a possession regime – but their ability to be harnessed to a property regime, above and beyond exchange value, that counted.
Depending on the monetary regime, that “intrinsic” or exchange value served a certain specific, delimited purpose. In a commodity-money regime, in which precious metals serve as money “base,” money “substitutes” are issued with this “base” as backing. Such a regime obtained in ancient Babylon; likewise, under the gold standard of the 19th century. In such a regime, it is not the circulation of precious metals that counts – the precious metals circulate hardly if at all, they being kept secure in bank vaults – but the engagement of credit and debt contracts, denominated in money terms denominated in terms of these metals, specifically gold. (Silver traditionally served as coinage rather than as commodity money, due to its relative abundance.)
Opposed to this regime is the regime of coinage. Contrary to popular belief, coinage does not establish a commodity-money regime. On the contrary, coinage is a fiduciary regime in which the value of the coin is artificially imputed by the issuing authority at a value above the “intrinsic” or market value of the metal. What is the point of that? Quite simple. In an age in which paper (or digital) money could not be contrived, it being too easy to counterfeit, precious metals were used, precisely to counter the possibility of counterfeiting, but yet at a nominal value below market value, so that they would remain in circulation and not be removed for other purposes.
Either way, borrowing and lending were conducted on the basis of collateral, using gold or silver as the form of money, because they were universally recognized and thus assured of circulation. As Sir James Steuart commented, it was the advantage of circulation for which interest was paid, and where this advantage is lacking, the rationale for borrowing is likewise lacking. Where paper money is accepted as circulating medium, as legal tender, its advantages over metallic currencies become plain. It was Steuart who in 1767, in his book An Inquiry into the Principles of Political Economy, first satisfactorily explained this situation and how it might be brought about.
James Steuart, the First Economist to Understand Banking
James Steuart is the “forgotten man” among 18th-century economists – forgotten because eclipsed by Adam Smith, whose Wealth of Nations enshrined the commodity view of money. His work only in our day is being rediscovered, it being the simplest and best explanation of the workings of money, credit, and banking. Through the examination of bank practice in his day – apparently something beneath the dignity of true economists – Steuart uncovered the principles which universally underlie the creation of money. These principles had been developed and applied in practice, without recourse to theory. (Theory, in this matter perhaps more than any other, has left practice to fend for itself.)
Steuart drew his primary example from the practice of Scottish banks, specifically banks of circulation upon mortgage or private credit, which in his day had proved unusually successful in spurring economic growth and development. Such banks were formed by associations of “men of property,” each of whom contributed to form the original stock, something “consisting indifferently of any species of property… engaged to all the creditors of the company, as a security for the notes they propose to issue.” This original stock is not used as money base: it is not the basis upon which the banknotes are issued. Rather, it is merely a guarantee of the good faith of the company. It is “a pledge, as it were, for the faithful discharge of the trust reposed in the bank: without such a pledge, the public could have no security to indemnify it, in case the bank should issue notes for no permanent value received.” Therefore, “large bank stocks … serve only to establish their credit; to secure the confidence of the public, who cannot see into their administration; but who willingly believe, that men who have considerable property pledged in security of their good faith, will not probably deceive them.”
What, then, is the money base? Not the bank’s own property, reserves, holdings, or stock; it is the securities given in exchange for loans. “So soon as confidence is established with the public, they grant credits, or cash accompts, upon good security; concerning which they make the proper regulations.” In this manner the bank, using a metaphor near and dear to Steuart’s heart, melts down solid property into “symbolical,” paper money.
This form of credit, called “private credit” by Steuart and consisting of credit against personal property, such as land and homes, is considered by him the most reliable form. Mercantile credit, on the other hand, being loans issued against the prospects of business enterprise, is less reliable and therefore subject to a higher interest rate. Thus, banks established upon private credit are sounder than those established upon mercantile credit. The form of security required by the bank, in exchange for which the bank lends, which determines the quality of currency it issues. “Which way … can the public judge of the affairs of bankers, except by attending to the nature of the securities upon which they give credit”?
The bank maintains a certain level of reserves, which in Steuart’s day were coin – for the notes issued were repayable in coin – in order to make repayments and to serve as a buffer for bad loans. “Nothing but experience can enable them to determine the proportion between the coin to be kept in their coffers, and the paper in circulation. This proportion varies even according to circumstances.” It is therefore but a percentage of the total outstanding loans. And it need be only that. To drive his point home, Steuart uses the example of “an honest man, intelligent, and capable to undertake a bank.”
I say that such a person, without one shilling of stock, may carry on a bank of domestic circulation, to as good purpose as if he had a million; and his paper will be every bit as good as that of the bank of England. Every note he issues will be secured on good private security; this security carries interest to him, in proportion to the money which has been advanced by him, and stands good for the notes he has issued. Suppose then that after having issued for a million sterling, all the notes should return upon him in one day. Is it not plain, that they will find, with the honest banker, the original securities, taken by him at the time he issued them; and is it not true, that he will have, belonging to himself, the interest received upon these securities, while his notes were in circulation, except so far as this interest has been spent in carrying on the business of his bank?
To minds steeped in the notion that money is the most marketable commodity, such a statement is astounding. And yet, it makes perfect sense. If money is issued against good security, it represents that security. It does not represent the bank’s property, but the borrower’s.
The Credit Crunch of 2009
In traditional economics, banking is said to be put upon a sound basis when the banknotes it issues are 100% backed by reserves, preferably gold. But this makes sense only when loans are made without requiring the borrower to put up any security of his own. Steuart saw this clearly: “When paper is issued by a bank for no value received, the security of such paper stands upon the original capital of the bank alone; whereas when it is issued for value received, that value is the security on which it immediately stands, and the bank stock is, properly speaking, only subsidiary.”
This being the case, the restriction of banking practice to a 100% reserve requirement amounts to an unsustainable shrinkage of credit, unsustainable, at least, to maintain economic growth of the magnitude to which we have become accustomed. For loans would not be made upon such conditions (i.e., no security) except to only the most secure borrowers. Or, if security were required anyway, the money base would still be so restrictive as to allow only a fraction of the loan volume of a modern economy. Circulation would be restricted to the amount of property owned outright by issuing banks.
Seen in this light, what is known today as fractional-reserve banking is not the tool of the devil many conservative economic commentators have made it out to be. In fact, even though it is based on a thorough misunderstanding, the underlying reality is simple common sense. If money represents the value of the security against which it is issued, the value of bank holdings is, to be blunt, irrelevant. That is not the value which is being represented. Bank reserves are necessary as buffers for bad loans, not as money base.
With this in mind, it can no longer be a mystery that financial markets collapsed in the credit crisis of 2008–2009. Good securities form the true money base, and if those securities are undermined, the very basis for the issue of money is compromised, leading to the fabled “credit crunch.” A spike of bad loans will cause a depletion of bank reserves far beyond the accustomed level. For the defaulting loan has to be covered somehow, and that somehow is by means of reserves. With the subprime-mortgage crisis, a huge amount of loans were issued against non-performing securities, and what made matters worse is that further loans had been issued against the security of these loans, resulting in a pyramid effect. This instigated a resort to bank reserves to cover the non-performing loans, and this on such a scale as to cause banks to stop credit operations, even amongst themselves. What was a liquidity problem had become a solvency problem. The existence of newfangled credit markets – the so-called Shadow Banking System – meant that the credit pyramid extended far beyond the banks themselves. These markets in recent decades had evolved well beyond the scope of the banking sphere, creating an interconnected web of credit involving all manner of economic actors the world over. “These disruptions to financing markets posed the same threats to the availability of credit to households and businesses that runs on banks created in the more bank-centric financial system of the 1800s and most of the 1900s. As a result, intermediaries unable to fund themselves were forced to sell assets, driving down prices and exacerbating the crisis; moreover, they were unwilling to assume the risks necessary to make markets in the debt and securitization instruments that were critical channels supporting household and business borrowing – and households and businesses unable to borrow were thus unable to spend, thereby deepening the recession.” All of this took place because the property base of money – good securities – had been sabotaged by the combination of misguided government policy and lax oversight.
To summarize, real-world economics – which in our society must be common-law economics – understands credit and debt to be the stuff of economic activity at its most basic level, with exchange of goods and services erected atop that basis. The common law provides the forms and institutions enabling expanding economic activity. Economic activity is conducted using the rights and jural relations the common law provides. This invisible web of commitments is what enables the cooperative activity of myriads of disparate individuals and associations to join together to form a dynamic economy. It is an entirely artificial phenomenon, formed on the basis of the legal institutions of acommon law – the law of citizenship, property, and contract.
In the course of time, these tools made possible, and indeed necessary, a new form of organization, the business corporation, based on a new form of property right, shareholding.
Shareholding involves forms of rights made possible only within the artificial framework of the common law. In the long gestation of the capitalist order, not only did the objects of the economy, the goods and services, become packaged in ever changing, developing forms, but the subjects, the persons involved in these transactions, did as well. First of all, there was increasing recognition of all classes of persons as citizens equal before the law, each susceptible of the same rights and duties of citizenship, regardless of wealth or the lack thereof. There also came the increasing recognition of women, either single or married, as having legal rights and standing.
There was yet another development: the recognition of corporate entities as having legal standing as economic actors in their own right, apart from the natural persons forming those corporate entities. The establishment of the principle of limited liability was the definitive confirmation of this form of organization. By restricting liability for a corporation’s actions on the part of its shareholders to only the amount of their shareholding, the corporation was separated from natural persons and became a person in its own right. Ownership of its shares is simply entitlement to the benefits of ownership, such as dividend payments, not absolute ownership, for a shareholder cannot withdraw his shares from the corporation; if he wishes to be rid of them, he can only sell them to someone else.
What is it about the modern corporation that makes it the logical extension of the developments traced above? It is clear that with the advance of credit and debt relations, monolithic groups rich in dependents become dissolved, issuing forth in smaller units more nimble and more capable of filling niche roles in the economy. The household remains the primary building block, but no longer the extended household, but rather the nuclear family. This results in an explosion in what we might term “budgetary units,” each of which, implicitly or explicitly, maintains a balance sheet, and which engages in the rights and relations of the common-law economy, the delineation of which is what the balance sheet provides. With all of this property and all of these property-owners now active, the “hidden assets” of the economy are brought into the open, “monetized” through the mechanism of credit operations, putting forth an unprecedented amount of capital in search of profitable application.
So there is the explosion in relatively self-reliant, productive citizens, based in the nuclear household, coming onto the market, engaging in production and consumption, seeking active employment; and there is the explosion of capital seeking active employment. The corporation is the organizational structure devised to channel these resources in the most effective manner. It focuses its energies towards a single goal, and can only accomplish that goal if it has the resources available which the common-law economy can provide. The labor market is where these corporations, large and small, go to get their workforces; the capital market is where they go to get the lion’s share of the funds needed to establish and operate their businesses.
Flies in the Ointment
These are the institutions of the capitalist order. They are the inevitable products of a common-law regime. They have made the West rich. But this is not to say that it is all peaches and cream. There are obvious possibilities for all manner of exploitation, fraud, corruption, and the like. But in the first place, it is not as if exploitation, fraud, and corruption are unique to the common-law, capitalist order. They are endemic to the human condition. It can be argued that this common-law order in fact restricts those phenomena better than any other.
But it is undeniable that there are certain openings in the structure which can be exploited by bad actors. Here are a few: the moral hazard problem, the tragedy of the commons, and the principal-agent problem.
The moral hazard problem is connected with the institution of insurance, and it points to a structural weakness in that institution: insurance actually promotes the behavior which is being insured against. If we insure against a certain risk, we will be less active avoiding that risk, because “the insurance will pay for it.”
The tragedy of the commons likewise afflicts the institution of insurance. In health care, for example, we maximize treatments and go for the most exorbitant solutions rather than the most cost-effective ones, because insurance provides a pool of money which is only tenuously linked to our own financial contribution. The result of this is that the cost of most treatments is driven through the roof, and needlessly so. This is why, in my considered opinion, health care needs to move away from the insurance model towards a pay-as-you-go model for the common everyday treatments that are usually required, reserving insurance – better, collective payment provision – for catastrophic or chronic conditions or situations. This is by far the best way to contain health-care costs.
Finally, the principal-agent problem, in which individual persons take advantage of corporate structures to maximize their own benefits and shift costs to others. This is obviously true of the business corporation, in which policies which are detrimental to the health of business are rewarded with bonuses, because the people in control are paying themselves the bonuses and not bearing the costs of their own decisions. But it is likewise true of government – the original corporation? – with bureaucrats and politicians maximizing personal gain by, e.g., doling out favors to lobbyists in exchange for having their own nests feathered, at the expense of the common good and the common purse.
These shortcomings are endemic to human nature, and are not specific to a capitalist order. They reappear in various manifestations no matter what the form of social order. Nevertheless, it is obvious that the moral and ethical underpinnings – the human capital – of the social order are the best hope and strongest bastion against such unethical behaviors. Custom and social pressure exert their effect here. And it is imperative that the transcendental, ideal framework upon which the economic order is based itself be nurtured, fostered, cared for, taken care of. And here we see the kingdom of God loom before our eyes. Either that kingdom will infuse these institutions, or something else will. The course of history is determined by this. “Now when the unclean spirit goes out of a man, it passes through waterless places, seeking rest, and does not find it. Then it says, ‘I will return to my house from which I came’; and when it comes, it finds it unoccupied, swept, and put in order. Then it goes, and takes along with it seven other spirits more wicked than itself, and they go in and live there; and the last state of that man becomes worse than the first. That is the way it will also be with this evil generation” (Matthew 12: 43–45).
 This orientation is true of all Western legal systems. Both the Anglo-Saxon and the Roman-law based systems of the Continent in their formative periods had this method as their modus operandi. The 19th century works of codification on the continent made great use of the received common law as so formed. It is a misconception to believe that the legislator simply decreed the lawbooks ex nihilo; this was not even the case for the Napoleonic Code Civil, much less the civil codes of Germany, Switzerland, the Netherlands, et al.
 The following is developed in Gunnar Heinsohn and Otto Steiger, “Collateral and Own Capital: The Missing Links in the Theory of the Rate of Interest and of Money,” in Steiger (ed.), Property Economics: Property Rights, Creditor’s Money and the Foundations of the Economy (Marburg, Germany: Metropolis Verlag, 2008), pp. 181ff.
 “Germans until this century called it a Rittergut, a knight’s estate, endowed with legal status and economic and political privileges, and containing at least fifty peasant families or some two hundred people to produce the food needed to support the fighting machine: the knight, his squire, his three horses, and his twelve to fifteen grooms.” Peter Drucker, Post-Capitalist Society (New York: HarperBusiness, 1993), p. 23.
 This, and what follows, is further discussed in my Common Law & Natural Rights (Aalten: WordBridge Publishing, 2009), pp. 57ff.
 Sir Henry Sumner Maine, Ancient Law: Its Connection with the Early History of Society and Its Relation to Modern Ideas (London: John Murray, 1861), ch. 2, “Legal Fictions.” For the origin of contract in tort, see Max Weber, Economy and Society: An Outline of Interpretive Sociology (Berkeley: University of California Press, 1978 ), vol. 2, pp. 645ff.
 Heinsohn and Steiger’s book Property, Interest, and Money is the first work of economics to recognize and utilize this distinction. Incredibly, it has yet to be translated. (The German edition is Heinsohn, Gunnar, and Otto Steiger, Eigentum, Zins und Geld: Ungelöste Rätsel der Wirtschaftswissenschaft (Marburg: Metropolis-Verlag, 2011 ).)
 “To practice economic science is therefore in the first place to concern oneself with institutions that allow people engaged in productive activity to make decisions with calculable consequences in a world which is irresolvably uncertain.… [Hence,] the object of economics is… the system of nominal – hence, money-denominated – contracts with which men engaged in productive activity activate and thus conjoin natural resources, performances, and assets… such that the goals pursued by them are made attainable.” Hans-Joachim Stadermann, Allgemeine Theorie der Wirtschaft: Band II: Nominalökonomik [General Theory of the Economy: Volume II: Nominal Economics] (Tübingen: Mohr Siebeck, 2006), p. 106.
 Anti-capitalism as a response to the regime of credit and debt is analyzed in ch. 8, “The Quest for Atonement,” in Common Law & Natural Rights.
 Commons views the growth of liberty as the shift from unreleasable debt, such as slavery or serfdom, wherein the “debtor” can do nothing to free himself from the service of the lord or master, to releasable debt, wherein the debtor may absolve himself by fulfilling the specific stipulations of the contract. This is none other than the shift from group-internal to group-external bonding. See John R. Commons, Institutional Economics: Its Place in Political Economy (New York: Macmillan, 1934), pp. 390ff., 457ff.
 For background to the following discussion, see my Follow the Money: The Money Trail through History (Aalten: WordBridge, 2013).
 Gresham’s Law – “bad money chases out good” – therefore turns the reality quite on its head. Rather, fiduciary metallic currency stays in circulation, while market-value metallic currency does not. Monetary authorities instinctively knew this, while monetary theorists never could quite get their heads around it. Precisely because their theory (state of nature oriented as it was) got in the way of the facts. Which reminds one of the apocryphal story about G. W. F. Hegel. A student says to him, “Herr Hegel, the facts contradict your theory,” to which he responded, “so much the worse for the facts!”
 “And for what does he pay… interest? Not because he has gratuitously received any value from the bank, since in his obligation he has given a full equivalent for the notes; but the obligation he has given carries interest, and the notes carry none. Why? Because the one circulates like money, the other does not. For this advantage, therefore, of circulation, not for any additional value, does the landed man pay interest to the bank.” Sir James Steuart, An Inquiry into the Principles of Political Economy, in The Works, Political, Metaphysical, and Chronological, of the Late Sir James Steuart of Coltness, Bart. (London: Cadell & Davies, 1805), Book IV, Part I, ch. 7.
 Smith’s presentation was far more congenial to the times, which were characterized by a penchant for physiocratic (nature-oriented) explanations of everything.
 Steuart, An Inquiry into the Principles of Political Economy, Book IV, Part II, ch. 4. This chapter contains the definitive statement in this regard. Unless otherwise noted, the following quotations come from it.
 “The ruling principle in private credit, and the basis on which it rests, is the facility of converting, into money, the effects of the debtor; because the capital and interest are constantly supposed to be demandable. The proper way, therefore, to support this sort of credit to the utmost, is to contrive a ready method of appretiating every subject affectable by debts; and secondly, of melting it down into symbolical or paper money.” Steuart, An Inquiry into the Principles of Political Economy, Book IV, Part II, ch. 2.
 Steuart, An Inquiry into the Principles of Political Economy, Book IV, Part II, ch. 5.
 The misunderstanding stems from the concept of “reserve banking,” a holdover from the days of the gold standard. In a commodity-money regime (as noted above), precious metals form the money base, against which money substitutes are issued. In such a regime, banks are required to maintain a reserve of the money base, which in the 19th century was gold. The reserve fraction was often set at one-third of total money “substitutes” issued. When the gold standard was abandoned, the notion of a reserve was held onto, as a means artificially to control the money supply, mimicking the gold standard’s control. In the United States, this is realized by the Federal Reserve System. Banks are required to hold a reserve at the Federal Reserve bank, which reserve serves as a set fraction of their currency issue. Hence the term, fractional-reserve banking. It should be obvious that, contrary to precious-metal reserves, this reserve holding at the Federal Reserve bank is no different in character than the money the bank issues on its own. It is thus an atavistic holdover, a fetish.
 A liquidity problem refers to a problem of converting assets into cash in the short term; in this case, the problem is not that there aren’t any assets, just that they cannot be put to use immediately. The assets themselves are still considered valuable. With a solvency problem, it is the assets themselves that have been depleted, either by having been withdrawn, or devalued to such a level that they virtually cease to exist.
 McCulley defines this system as “the whole alphabet soup of levered up non-bank investment conduits, vehicles, and structures,” all of which, not being banks, were neither insured under FDIC, nor regulated in the manner of banks. See the Wikipedia entry: http://en.wikipedia.org/wiki/Shadow_banking_system.
 Donald L. Kohn, “The Federal Reserve’s Policy Actions during the Financial Crisis and Lessons for the Future,” remarks to Carleton University, Ottawa, Canada, May 13th, 2010. Available at www.federalreserve.gov.
 It should be recognized that behind this “bad policy and lax oversight” was a liquidity glut that virtually forced lenders to turn to such ridiculous measures. In other words, it was not mere greed on their part, but the necessity to generate returns where no returns could be found. The supply of liquidity far exceeded demand. This liquidity glut, in turn, was the result of massive trade imbalances generated in particular by China, “financed” by bank lending, which financing ended up circulating endlessly in the money markets. Which is another story in itself.
 We can each entertain our own judgement as to the beneficence or otherwise of this state of affairs. The point here is to recognize reality and understand it. Only then can we devise functional policies, i.e., policies that will be effective.
 For a thorough discussion of the household, firm, etc., as budgetary units, and the banking system as a gigantic clearing house of transactions between these budgetary units, see Joseph Schumpeter, Treatise on Money (Aalten: WordBridge, 2014), pp. 131ff.
 The theme of hidden assets as the key to economic development is developed extensively by Hernando de Soto. See his The Other Path (first edition Basic Books, 1988) and The Mystery of Capitalism (first edition Basic Books, 2000).