No one can dispute that an excess of demand over the supply available to satisfy it will on a reasonably effective market push up prices temporarily. That is the legitimate use of the term "inflation." But that is not the same as reversing the proposition and affirming that whenever price moves up that the reason is an excess of demand over supply.

It could well be that our society require a greater input of public over private services, and to pay for this requires higher taxes. Over the past few centuries but particularly since World War II, the world has undergone unprecedented revolutions in technology, population explosions, migrations, and urbanization. Even a tenured economist moving from the countryside to a modern metropolis cannot expect his living costs to stay the same.

This is not a difficult thing to grasp. Just to formulate it is enough to see the costly fallacy in the proposition that prices are up so we must drive up interest rates. For interest rates are a major cost of everything we produce. Or that oil is getting scarcer and costlier, so the central bank must raise interest rates. Not a single teaspoon of oil was ever found or produced or conserved by raising interest rates.

For some forty years now I have made the point that a higher price level may indicate real market inflation, but it could also be a strictly structural effect of the increase of the public sector component of our production. This I called the social lien. But you may call it whatever you want provided that you don’t mistake it for inflation, since it has different causes and hence some very different effects. Governments have shut their eyes to this distinction, though for a brief period a year or two ago even the Federal Reserve and the Bank for International Settlements started making a distinction between "good inflation" up to 2 or 3 %, and "bad inflation" beyond that. For almost a year, however, we have heard no more about "good inflation." What a way of running a discipline on which society’s survival depends!

Those who have proclaimed the goal "zero inflation" and reduced the weaponry to achieve it to "one blunt tool" – higher interest rates – have a vested interest in higher interest rates per se. We must conclude the goal of those in the saddle was to harness rather than to understand the phenomenon. High interest rates are the favoured vehicle of the usurer in the process of becoming a general financier or vice versa, but they are inimical to efficiency and production. It is not easy convincing the hawk swooping into the skies with a chicken in its beak that he will hurt it. That was the purpose of its flight.

This makes a clear distinction between spending for items consumed within the current year and acquisitions that have a longer life. In the case of real estate the building may have a useful life of a half century, but the land beneath it can possibly go on increasing in value long beyond that. That depreciated value must be recorded as an asset. This always has been done in the private sector. When not, the owner is open to prosecution. Hiding the unused value of a building or equipment and taking a tax credit for its full cost as an expense would be cheating the tax-collector. Pretending that a capital asset was there when in fact it was used up or become worthless would bilk the company’s shareholders. Our governments, however, not only resisted the advice of a Royal Commission or two and a long line of Auditors-General to introduce accrual accountancy; when the penultimate one refused to approve unconditionally two consecutive balance sheets of the federal government, the then Finance Minister, Paul Martin, had an unseemly row with him, during which the Auditor-General actually used the words "cooking the books." Finally a compromise was reached with the A-D signing a demeaning statement saying that since no money had been found by introducing accrual accountancy, it is not to be taken as a reason for spending more money. But couldn’t that statement be turned around to read: since no money had actually gone out by the failure to bring in accrual accountancy, there was no reason for Finance Minister Paul Martin to slash the grants to the provinces?

The costs to society of these imprudent games have been multiple. To begin with, writing off a capital asset in one year creates a fictitious deficit, which is used to collect more taxation than would be needed to balance a budget based on serious accountancy. And like many indulgences, those who practice them cannot stop but go onto the next thing. Thus Prime Minister Martin, while resisting the insistence of the Auditor-General for the introduction of accrual accountancy, made a practice of stashing still further government funds, using them as a reason for slashing vital programs only to bring them forth when the new budget is brought down. This allowed him take a still grander bow for his "prudent management."

In the private sector such prudent management could earn its perpetrator a prison term.

But there are neglected capital assets of governments that even accountants still don’t recognize. These are their investments in human capital – education, health and social welfare. The surprisingly rapid recovery of Germany and Japan from WWII led Theodore Schultz to the conclusion that investment in human capital is the most productive investment that can be made. For that work Schultz was awarded a Nobel Prize for Economics, but his work today has been erased from official memory. It matters little that the investment in education ends up in private minds and bodies. What is decisive is: it is indispensable in this high technological age to running our economy and it adds immensely to the tax-base. And once you recognize that, you must bestow the same recognition on the vessels in which that government asset is stored – human minds and bodies. Up to now – along with the environment and much else – these have been classified as "externalities" and disregarded. Under complete accrual accountancy the failure to maintain human investment or the environment adequately must be treated as a loss rather than as an economy. This was agreed upon in theory in the agreement that was finally arrived at by Finance Minister Martin and Auditor-General Desautels in 1999. But why has this not been explained to the public?

There were of course abundant financial group interests behind the resistance of the government to these basic accountancy principles. There was an immense advantage in having the government in deepening debt both because of the poor accountancy mentioned, and the syphoning off of public assets in multiple ways that it made possible. For example, the fabulous deals disposing of government assets carried on its books at a token value. Whatever they were sold at could be applied to reducing what was in large part a fictitious debt. That happened with the Canadian National Railways federally, and with Highway 407 that was privatized by the Government of Ontario. The new owners usually lost no time in organizing a public company, selling shares at an immediate profit. And then it charged the public bloated user-fees for what had already been paid for in taxes.

But the main coup was directed at what has always been recognized as the essence of the nation’s sovereignty. In antiquity and the middle ages and well into the 20th century, this was identified with a government’s monopoly in coining precious metals. The chequing institution of modern banking provided the technical basis for shifting much of these so-called "seigniorage" powers to the multiplier of the credit the banks could create on a given money reserve in their vaults. The very word "seigniorage" derives from the Italian for "lord" or "Master." It emphasizes the modern parallel of the sovereign’s power to recall the gold or silver coins periodically and recoin them with a lower metal content. Since the church in medieval times paid no taxes in return for looking after the communications with Heaven, and the landowners did their share in practice or theory by standing ready to defend the realm, while the serfs were paid in kind and could hardly be expected to pay taxes in money, it was only merchants who engaged in considerable money dealings. They alone could and would pay money taxes. The system has been judged by scholars an efficient taxation system. So efficient was the Anglo-Saxon practice of coining and then periodically recalling the coins for recasting them with lesser metal that the Normans on conquering England kept the Saxon system in force. In France on the contrary hundreds of little domains with coining rights were a main factor in France’s late development as a united nation with an effective tax system.

But there is a crucial difference between gold and silver coining and coin-clipping of ancient and medieval times and the credit creation of our banking system. The available supply of gold and silver even after the discovery of the New World had serious difficulty in keeping up with the spreading needs of trade. Bank credit on the other hand in the minds of the bankers at least, acknowledges no such restraints. A long line of philosophers and sages have described bank credit and paper money both as an invention of genius but potentially also a swindle. What determines which of these in fact it turns out to be, depends largely on the amount of money that is created. If it corresponds less to the needs of trade than it does to the greed of its creators, the swindle variant takes over.

And the essence of my tale is how the bankers who had already contributed more than their fair share in bringing on the Depression of the Thirties, and through it the Second World War, have once more covered much of the ground that led to the 1929 Wall St. crash.

In 1929 you had in embryo form many of the essential features of banks’ takeover of the world economy that has achieved such virtuosity today: the same over-extension of the banks, their invasion of the stock market and real estate. The power trust of Samuel Insull in the US went through the same boom and bust trajectory as Enron has in our day: massive loans of American banks to Latin American dictators was a hallmark of the age. And by the time Roosevelt was inaugurated 38% of US banks had already closed their doors.

And that is why the Roosevelt banking legislation, brought in in 1935, essentially confined the banks to the doghouse. They were not allowed to merge their interests with the other financial pillars – real estate mortgage companies, the stock market or insurance. The government, moreover, provided deposit insurance. Without it, it is a moot point whether banks could have opened their doors again. The banks, completely discredited, had lost their power, and that is what made it possible for the government to impose these restrictions on them.

Elsewhere in this issue we describe some of the details of their great comeback. By the 1980s they had been considerably deregulated and a campaign was in full force to remove the Rooseveltian restrictions from them. The most crucial steps in this direction took place when the banks had lost much of their capital in the boom of the 1980s in world real estate and gas and oil. In the 1930s the situation was considered so serious that the Roosevelt administration would lend an ear to anyone who seemed to have an original idea that might lift the country out of the mess. The opposite was the case in the crisis of the late 1980s.

Under the Roosevelt Bank Act of 1935, the banks were not allowed to acquire any of the other three financial pillars. But their pools of reserve cash needed for their own affairs invariably proved tempting to the bankers for the application of their multiplier to a grand compounding of the money bases of all four pillars. It was the relaxation of these controls that caused the US and world banks to lose most of their capital, and paved the way for the Great Bailout of the 1980s.

From these bits of history, a disturbing conclusion emerges. The economy has been taken over by a deregulated banking interest that regards not only the economy, but society and the government itself as part of its exploitable domain. The deregulation that it has achieved gives it not only what it claims as its rights, but a trajectory of accelerating growth into the remotest future. This is substantially pre-incorporated into the current price of its stock-market shares. And that is a commitment under penalty of having the entire structure of credit, supported by girders of similarly evaluated collateral, cave in.

Up to now it has narrowly escaped disasters by secretive and semi-secretive revisions of the reigning dogmas that have warped the accountancy of our government and corporations. When there was no other way out the government and international institutions swerved from the norm of aggressive usury to a greater recognition of the creditworthiness of central governments. For the latter is the ultimate anchor of the credit system of any society. The retreat from the deadly combination of sky-high interest rates that had been the only way of combating "inflation" and supposedly risk-free government debt that was the essence of the last bank bailout and in one form or another the only possibility of the next. This gave the battered system a new spell of life. For a year or two during which the Bank for International Settlements and even the US Federal Reserve started talking of good inflation – up to 2% or 3% – served the same purpose. However, all talk of good inflation has long since disappeared – characteristically without explanation. In actual fact what they were alluding to was not inflation at all but what I termed the "social lien."

The impossibility of combining high interest rates "to lick inflation" with the license to the banks to load up with federal government debt without putting up any equity of their own gave way to lower interest rates that had some unforeseen positive effects. Homeowners could increase their existing home mortgages and use the additional amount to improve, if not their lives, at least their life styles. It would have been far better to bring in the changes fully, honestly and openly to provide lower interest rates that on a permanent basis would shift income from usurers to actual producers. But that would have gone counter to the prime agenda which since the 1950s has been to alter beyond recognition the distribution of the national income in the opposite direction.

These two expedients have long since been used up in further orgies of expansion of consumer credit and stock market excesses. Since their real nature was kept secret from the public, it cannot be widely appreciated that, once exhausted, they do not lend themselves to be encored. There are no further statutory reserves to do away with in Canada, nor to tuck into insignificance in the US or the UK. The same may be said for the system of refinancing homes to extract the additional collateral value resulting from a booming house market and the decline in interest rates to release more consumer credit to continue the boom. Meanwhile the international automobile industry – against a background of soaring fuel costs – has gone wild in expanding far beyond what the market can absorb for a variety of commanding reasons: fuel prices, highway congestion, pollution and possible market demand. That points our future in the direction of further military solutions. These provide a certain market; the only acceptable justification for increased government spending in the conservative circles that dominate the scene in the leading countries. Unless we rediscover the lessons of history it could prove curtains for the human race.

-- from Economic Reform, July 2005