The Many Fallacies of Ellen Brown
Michael S. Rozeff
by Michael S. Rozeff: Government
by Force: Financially and Conceptually Bankrupt
who is an attorney, has written an article about what she calls
Economic Bill of Rights". I will argue that her case is
totally wrong. It is totally permeated with factual and conceptual
my showing precisely how her financial analysis is in error, we
can understand that she is propounding nonsense by looking at her
the government owned the banks, it could keep the interest and
get these projects at half price. That means governments – state
and federal – could double the number of projects they could afford,
without costing the taxpayers a single penny more than we are
opens up exciting possibilities. Federal and state governments
could fund all sorts of things we think we can’t afford now, simply
by owning their own banks."
government to double in size. That would make it 80 percent of the
economy. This is nonsense. It is an impossibility. If government
becomes 80 percent of the economy, the economy will shrink drastically
because productivity will plummet. Not only that, huge amounts of
capital will flee the country.
that this expansion can be done costlessly. That is, she thinks
that the resources absorbed by government are costless. This is
patently false. All resources diverted to government are taken away
from persons who would otherwise use them for their own purposes.
The diversion removes the opportunities for private use. Hence the
cost of the diversion to government is, at a minimum, the opportunity
cost of those resources or capital. And that’s a minimum cost because
it excludes the costs the government incurs in seizing the resources
and the costs incurred in misallocating those resources after they
understand the effects of government on private economic behavior.
She doesn’t understand government’s inefficiency and incapacity
to be productive. She doesn’t understand cost, that is, opportunity
that there is a governmental free lunch. She thinks she has discovered
a free lunch that has up to now eluded realization and perhaps discovery
by the human race. She seems not to realize that the Russian and
Chinese Communists did what she is proposing. They absorbed all
the banks. They mobilized all the capital they could lay their hands
on. They funded all sorts of things. The costs of seizing this capital
were enormous. Millions of people were killed, imprisoned, and sent
to gulags. Millions were impoverished. Misery mushroomed. The results
were total failure.
in rebutting what she says is that her message has been reduced
to a simple catchy theme. It is a false theme, but it still has
the power to attract. Her theme appeals to anti-banker sentiments.
It appeals to anti-interest sentiments. She asserts that the prices
we pay for goods are 40 percent interest costs. This catches one’s
attention, but it is total nonsense. It is totally wrong. It is
outrageously high and exaggerated.
She goes on
to assert that this cost, whatever size it is, magically disappears
if government owns the banks. This is also entirely wrong. If a
government company builds a car, the capital it obtains in order
to begin production has, all else equal, the same cost as if Toyota
were to obtain that capital. Capital costs do not disappear because
production is socialized in the realm of government ownership. Capital
still remains scarce.
Brown exaggerates the amount of capital supplied by banks. Somewhere
around 60 percent of debt capital is supplied to businesses by the
direct purchase of debt instruments in capital markets (estimated
flow of funds accounts). Banks don’t supply much long-term debt
to businesses. Since debt is about 1/3 of overall capital and the
rest is equity, banks supply about 0.4 x 0.33 = 13.2 percent of
all capital to businesses. These are rough figures, but refinements
won’t change the overall conclusion. Even if Brown’s nirvana of
socializing or nationalizing banks were brought into being, it wouldn’t
touch the vast majority of capital that
is directly supplied to companies.
I will now
argue that her 40 percent figure is vastly overstated. To do that,
we will take an excursion through the basic finance of which Brown
is apparently ignorant.
What is capital?
Capital consists of all goods that people intend to use for activities
that are intended to satisfy future wants, as opposed to consumer’s
goods that are used to satisfy immediate wants. Capital is measured
in terms of a money unit of account.
that produce goods for future consumption use capital in their processes
of production. This capital is scarce, which means it is definitely
not free or costless. There is competition to obtain capital. There
are markets for it called capital markets. There is supply of capital
and there is demand, and their activity produces a cost of capital
that is positive or above zero. If the price or cost of capital
were zero, the demand for it would vastly exceed the supply.
has a cost, which is in fact called the "cost of capital".
This cost doesn’t vanish if a business owner supplies his own capital
to his own business. A person who uses his own capital in his business
loses the opportunity of supplying it to others at the market price.
He loses income that he could have gotten by allowing others to
use his capital. This person has an opportunity cost of capital.
If he makes a rational calculation and accounting, he should demand
of his business that it pay back to him this implicit cost of capital
that he has diverted away from an external market and used instead
for his own business purposes. What he has given up by not placing
his capital in an external market he should at least recover by
using it for his own purposes. He should, in essence, pay himself
for the use of his own capital.
The cost of
capital doesn’t vanish if a government takes capital from its citizens
and uses it for government activities or government-owned businesses.
If we think of the government as a kind of organization owned by
citizens, then, in the employment of capital by the government,
the citizens are analogous to a business owner that employs his
own capital in his business. That is, there is still a cost of capital
used by the government when citizens supply their capital or are
forced to supply it to the government. They lose the opportunity
of deploying this capital elsewhere in productive enterprises, and
that loss measures the cost to them of government’s absorption of
In other words,
no magical gain occurs when government absorbs and deploys the capital
that it extracts from citizens. The basic reason that no gain occurs
is that capital is scarce, which means it has a cost. That cost
doesn’t vanish as capital is shifted from one owner to another,
including government ownership.
to recognize this basic fact. She wrongly thinks that if government
keeps the interest that it gets its projects at half price. All
that happens, however, is that government recovers the cost of capital
for itself. The projects don’t cost any less at all. Her error is
like thinking that a man who uses his own $3,000 to build a motorcycle
can build it at half the cost of someone who borrows the $3,000
from a bank to build it. Obviously the costs of the materials, labor,
and so on are the same. The cost of the capital is less obviously
present. With bank borrowing, the man pays interest. Let us suppose
that it’s at 6 percent for one year, so he pays $180. The man who
uses his own $3,000 loses the opportunity to invest his funds externally.
If he can invest at 6 percent, he loses $180. This is a real cost
to him of using his own funds. There is a finance cost regardless
of whether the bank funds the project or the man funds the project
All users or
demanders of capital bear the cost of capital. They pay it to capital
suppliers to induce them to save, that is, to forego consuming their
resources and instead to invest them. The cost of capital also includes
payment for the risks that savers bear when they transfer their
capital to the users of capital.
Next, I expose
the absurdity of her 40 percent number.
How large are
capital costs? A significant company might have 1/3 debt and 2/3
equity capital. The cost of debt might be 6 percent. The cost of
equity might be 9 percent. The weighted average cost, excluding
tax effects, is then 8 percent (1/3 x 6 + 2/3 x 9). These numbers
are made up, but they give a reasonable idea of overall capital
cost. I will use that 8 percent figure below.
A company employs
capital and it has a balance sheet. On one side, the left hand side,
are the assets employed in the business. The left side provides
measures in money terms of the assets that the business managers
have decided to employ in the business in their production processes,
such as buildings, a cash account, inventories, vehicles, computers,
etc. The left side assets are capital in forms thought to be productive.
On the other side of the balance sheet, the right hand side, are
the liabilities (debts) and equity (or ownership) capital that finance
the business. It shows capital in the form that capital-suppliers
have agreed to make available to the business. The balance sheet
always balances. The money valuation of the left side assets equals
the money valuation of the right side liabilities and equity capital.
We may use either total to measure the total capital deployed in
We see that
the total capital employed in the business is measured in book value
(accounting) terms by either all the assets on the one side or all
the capital (debts + equity) on the other.
Let’s do a
hypothetical example in which we use the cost of capital as 8 percent.
Suppose the company has $100 of assets. Then it has $100 of capital
in the business. These assets have to earn $8 in order to cover
capital costs of one year. Suppose that the business has sales revenues
of $150 during the year. The revenue is not business profit. Much
of this revenue will be absorbed by operating costs, such as payments
for labor services, payments for energy, payments for goods purchased
from other companies, payments for transportation, payments for
advertising, payments for distributions, etc. One of the costs is
the cost of capital. On income statements that calculate business
profits, the costs of debt are explicitly accounted for by interest
costs. The costs of equity capital are not explicitly accounted
for, but they are still real. It is a mistake to overlook them.
attempt to lower their costs so as to produce greater profits. They
will attempt to obtain capital to finance the business at the lowest
cost they can, all else equal. They might conceivably measure their
capital cost as a fraction of their sales revenues. This ratio is
not one that is ordinarily calculated in doing a financial analysis.
This is the ratio that Ellen Brown cites and relies upon as being
about 40 to 50 percent.
In our example,
the ratio is $8/$150 = 5.33 percent. The estimate of 40-50 percent
intuitively seems way too high, and it is way too high. It means
that on a complete income statement of this company the capital
costs are $60 to $75. Suppose we use the 40 percent number or $60
of capital costs. Suppose that debt costs are 6 percent. With debt
as 1/3 of capital, that means that debt costs are 0.06 x $33.33
= $2. That leaves $58 for the equity costs. The equity costs are
$58/$66.67 = 87 percent. This is outlandishly high. It is caused
by Brown’s outlandishly high estimate of 40 percent capital costs.
Actual equity costs in the real world are nowhere near 87 percent.
They range from 8 to 15 percent for many established corporations.
They run higher than that for more risky enterprises, perhaps 15
to 25 percent. They don’t run 87 percent for businesses with reasonable
be more reasonable? In my example, if $8 are capital costs and if
$2 of this is for debt, then the remaining $6 is for equity. The
equity cost is then $6/$66.67 = 9 percent. That is more reasonable.
Very long run returns on common stock equity are near this number.
Long run returns on the accounting value of equity may run somewhat
higher, more like 10-12 percent. That still comes nowhere close
to a number that justifies the assertion that capital costs are
40-50 percent of the selling price of goods, and that is what Ellen
to Margrit Kennedy, a German researcher who has studied this issue
extensively, interest now composes 40% of the cost of everything
we buy. We don’t see it on the sales slips, but interest is exacted
at every stage of production. Suppliers need to take out loans
to pay for labor and materials, before they have a product to
line proposal is that the government create money instead of the
banking system. She wants the government to set up its own banks.
She says that this would bypass "the interest tab". We
have seen that this doesn’t bypass the cost of capital at all, not
when that capital comprises real resources and the government absorbs
these resources. But Brown has another fallacy in mind which is
that fiat currency will eliminate the capital cost. She wants the
government banks to issue fiat currency which is non-interest bearing
and in this way fund projects at what she thinks is a zero capital
Picture a government
printing press for currency. Citizens are required to accept the
newly-printed paper in payments for goods. Obama’s lieutenants take
the paper currency and spend it for their favorite projects. All
this amounts to is a different kind of taxation scheme by which
the government absorbs (seizes) resources that are in limited supply.
The opportunity costs of these seized resources still do not vanish
no matter whether the resources are seized directly, taxed through
the IRS, or obtained by spending new pieces of green paper.
is committing the same fallacy as the Communists who attempted in
vain to get rid of interest. It is an impossibility. The interest
measures the postponement of consumption and arises because of it.
If there are to be any production processes, they require capital
and non-consumption. There will have to be interest. If interest
is forcibly suppressed, capital will flee and people will engage
in greater consumption. Capital will be consumed and the economy
will go downhill. Government printing presses amount to taxes on
capital. They will have the same results.
There is much
that is wrong with our monetary system. There are a good many critics
of it who are offering sound criticisms and sound recommendations
for improving it. Ellen Brown is not among them.
S. Rozeff [send him mail]
is a retired Professor of Finance living in East Amherst, New York.
He is the author of the free e-book Essays
on American Empire: Liberty vs. Domination and the free e-book
The U.S. Constitution
and Money: Corruption and Decline.
© 2011 by LewRockwell.com. Permission to reprint in whole or in
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